Uncertainty - A Blessing for Traders and a Nightmare for Passive Investors

In his play, The Comedy of Errors, the iconic playwright William Shakespeare wrote, “Until I know this sure uncertainty, I’ll entertain the offered fallacy.” Human beings embrace certainty, but it is often a fallacy because what is certain at this moment can become false in the next.

Sentiment is the market’s attitude or opinion that drives asset prices higher or lower. In a 2004 book, The Wisdom of Crowds, author James Surowiecki documented why crowds make better decisions than individuals, even when those individuals are “experts.” Markets embody crowd wisdom as the sentiment translates to buying or selling, driving asset prices higher or lower. Crowd wisdom reflects a certainty of the current sentiment, which can change in the blink of an eye. While passive investors embrace certainty, traders thrive in the uncertain conditions that create price volatility. As we head into the fall of 2024, uncertainty has increased.

The geopolitical landscape- A hornet’s nest

• NATO continues to support Ukraine in its war against Russian aggression. Any escalation could cause a direct conflict between the NATO alliance and Russia.
• The Middle East conflict has escalated, with Israel facing threats from Iran and its proxies. Iran is on the cusp of becoming a nuclear power, further destabilizing the region.
• China has made no secret about its reunification plans with Taiwan. A conflict over Taiwan threatens peace in Asia.
• North Korea has increased its nuclear arsenal, further threatening conflicts in the Asian theater.

The U.S. election takes dramatic turns

• Former President Trump survived a July assassination attempt.
• After a poor debate performance and polls, President Biden withdrew from the November U.S. election.
• Vice President Kamala Harris will face former President Trump in the U.S. November election.
• The polls have tightened, making the election a toss-up.
• The election results will determine the U.S. foreign and domestic policies over the coming years.

The Fed’s economy- Could they have waited too long again?

• The U.S. Fed left the Fed Funds Rate unchanged at the end of July’s FOMC meeting.
• Recent jobs data increased concerns that the U.S. economy is moving toward a recession.
• The Fed waited too long to increase interest rates when inflationary pressures grew after the pandemic.
• The recent stock market turbulence could indicate that the central bank has waited too long to reduce interest rates.

A critical sentiment barometer

• The VIX measures the implied volatility of call and put options on S&P 500 stocks.
• The S&P 500 is the most diversified U.S. stock market index.
• Options are price insurance. Premiums rise when the market declines and fall during bullish trends.
• The VIX exploded to the third-highest level in history on August 5 when it traded over the 65 level.
• The spike in the VIX was a warning sign for stocks and markets across all asset classes.

The rules to survive significant price variance

• Higher volatility is a nightmare for passive investors but creates a paradise of trading opportunities.
• Rule one is to approach all trading and investment positions with a stated risk-reward plan.
• Rule two is to stick to the plan when an asset moves contrary to expectations.
• Rule three is to adjust risk-reward dynamics to reflect the current price, not the execution price when markets move in the anticipated direction.
• Rule four is to put all ego aside and understand that market prices are never wrong, as they are the level where buyers and sellers meet in a transparent marketplace.

Market sentiment can be correct or incorrect over time but always creates the right momentary price. Uncertainty about the economic and geopolitical landscapes is a prescription for increased price variance in markets across all asset classes. Respect the wisdom of the crows while identifying opportunities. A logical risk-reward plan and discipline are the path to thrive and survive during turbulent market conditions.

Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!