INSIGHTS

TRUE UNCERTAINTY RISING: SCARIER THAN RISK

Ed Peters
|
November 17, 2021

“About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.” -John Maynard Keynes

The markets seem to have wide and contradictory forecasts for a limited number of risks:

1) Stock market valuations
2) Central bank policy
3) Inflation
4) Cryptocurrency

Differences of opinion are normal, but current disagreements may point towards something more ominous than risk: true uncertainty. While common usage makes risk and uncertainty synonymous, many think otherwise. Risk is usually a well-defined problem that can be quantified by the probability of events. True uncertainty, on the other hand, encompasses problems so complex that probabilities cannot be calculated because we largely do not fully understand the process or the likelihood of events. Keynes wrote the above quote in “The General Theory of Employment” (1937). In 1921, Frank Knight wrote about true uncertainty so convincingly that we often refer to “Knightian Uncertainty.” I, myself, wrote about true uncertainty in my 1999 book, “Patterns in the Dark.” While an old idea, true uncertainty is so frightening that references hardly occur in day-to-day analysis.

But now the wide variety of passionately held expert opinions on a narrow set of topics may point towards a rise in true uncertainty. Everyone agrees that stock market valuations are high, but well-known pundits can either say that is not a problem because there is no alternative to stocks (TINA), or that low returns are inevitable for the next 10 years. Likewise, many respected analysts and former central bankers are either saying that the Fed is making one of the biggest blunders in history or the Fed’s patience will be rewarded. Some see inflation as temporary, while others see embedded inflation that’s rapidly getting worse. Many say cryptocurrencies are the future, while others think they’re a modern day tulip bulb craze. The wide dispersion of expert opinion suggests we are in a state of true uncertainty.

What makes true uncertainty frightening? We use probabilities to make “rational decisions” under conditions of uncertainty. Such behavior gives us a feeling of control because we believe that we understand the process even if the outcomes are probabilistic. But making probabilistic decisions under conditions of true uncertainty gives us an illusion of understanding and control that is actually irrational, since likelihoods are unknown. If we are, indeed, in such an environment, what happens next is anyone’s guess. And that’s scary.

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© First Quadrant, LLC, 2021. Intended for Institutional and Qualified Eligible Persons Use Only. The views expressed are the views of First Quadrant, LLC, only as of the date shown and are subject to change without notice based on market and other conditions. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice, recommendation, or solicitation of any particular security, strategy or investment product. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of domicile. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

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