Market Outlook – March 11, 2003(A)

As the world sits breathlessly waiting for war, dread and anxiety incite each other with every passing headline. Investors are struggling, not always successfully, to gain perspective in the midst of such high emotion. One classic error investors make in these situations is to mistake uncertainty for risk.
We take it as given that the outcome of a US invasion of Iraq will be neither as dire as feared by some nor as orderly as predicted by others. Between those two poles lies a maddeningly complex range of possibilities that no one can effectively arbitrage. That’s what’s called “uncertainty” as opposed to “risk.” Risks you can calculate. Uncertainty, you can’t.
The peculiar result of such extreme uncertainty is a reversal in the usual relation between near-term and long-term expectations. Usually we have greater confidence in near-term outcomes than we do long-term ones. I can usually tell you what I’ll be doing tomorrow with much greater confidence than I can muster about what I’ll be doing two years from now.
The situation in the markets today, however, is just the opposite. Confidence in the near-term is much lower than in the long-term. Nowhere is this reversal captured more clearly than in the market for oil. To buy oil for immediate delivery (the “spot” price) today you have to pay $37.10 a barrel. To buy oil for delivery in December of 2004 you pay only $25.18 a barrel.
The dramatic difference in price reflects the fact that our confidence in the availability of oil near-term is much lower than our confidence in its availability over a year from now. Nobody knows what’s going to happen in the next few days but we assume the markets will have returned to normal in the future.
As pricing in the oil markets illustrates, we are in the midst of a highly unusual, temporary disconnect in the way markets operate. It’s as if this spike in uncertainty pressed a “pause” button. Corporate executives have frozen hiring and capital spending plans while investors are sitting on the sidelines in cash or bonds. Everyone wants to “wait and see.”
The effects of this attitude are a sputtering economy deprived of the fuel of new jobs and capital investment and a softening stock market where buyers have all but gone on strike.
But just as it would be foolish to buy oil at these inflated prices unless you had to, so it would be foolish to sell stocks at these depressed prices unless you had to. Indeed, just the opposite is indicated.
For amidst all the uncertainty, one thing is highly likely: that this paralyzing near-term uncertainty will be resolved in the near term. Whatever the outcome, once action is taken in Iraq and some (almost any) shape is given to the situation the markets, investors and corporate executives will resume operating more normally. That is, they will resume calculating risks and taking action based on those calculations. They will press “play.”
We think the odds are very good that when they do the economy and the stock market will improve, perhaps dramatically. We know that’s hard to imagine. But at times like these, it always is.