Why does the market hate uncertainty?


The market likes to know what is going to be happening tomorrow, but unfortunately the markets are just generally uncertain.

I can’t tell you whether or not the stock market will be higher or lower tomorrow.  I can’t tell you what is going to be happening in the Eurozone.  I can’t tell you what is going to be happening in China.  So therefore there is always uncertainty in the market.

But what analysts like to do is to put numbers into their spreadsheets.  They want to know that, if they were buying shares in a company, let’s say Brambles (ASX: BXB), they would like to know what the company’s profits are likely to be in 2013, 2014 and 2015. Only by having that information are they able to discount all of those profits back to today, to come up with a valuation for Brambles.

Now, analysts can’t do those calculations with certainty for various reasons. They don’t know what will be happening to interest rates, or what is happening to sales. These factors create the uncertainty which makes it very difficult for them to come up with a valuation for this particular company.

So analysts calculate the risk to see whether the risks are greater now than they were before.  When they are greater the share price gets marked down, which is why you tend to find, when things are very uncertain, the risk premium starts to increase, and so therefore the share price starts to fall.

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A version of this article, a podcast by David Kuo, originally appeared on fool.co.uk

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