Every day it seems like the world is becoming more connected. If you watch any financial TV channel or read news online, you are likely aware of how events in one country are having an increasing impact on other countries around the world.
Certain aspects of globalization may have positive benefits, but when threats of financial crisis, war, global recession, trade imbalances, etc. arise, it often leads to talk of moving money into safer investments and increasing government deficits. This growing uncertainty can confuse even a well-informed investor.
Key Findings
- When investing, there is always a certain level of risk and uncertainty, which increases during times of wars, recessions, pandemics and other negative events.
- When times get tough, investors move their money out of stocks and into safer assets such as precious metals, government bonds and money market instruments.
- The movement of investors' capital from stocks to safer assets leads to a depreciation of the stock market.
- Uncertainty affects the economy at both the micro and macro levels: at the micro level it focuses on companies and individuals, and at the macro level it focuses on the economy as a whole, such as global oil prices and capital flight.
- By being well-informed and adjusting your investment strategy as events change over time, you can invest wisely during uncertain times.
- Diversification is a key investment strategy that prevents significant losses if one area of your portfolio takes a major hit.
The impact of uncertainty on investing
Any time you risk money in an attempt to make a profit, there is an inherent level of uncertainty. When new threats arise, such as war or recession, the level of uncertainty increases significantly as companies can no longer accurately predict their future earnings.
As a result, institutional investors will reduce their exposure to stocks considered risky and move funds into other asset classes such as precious metals, government bonds and money market instruments. This sell-off, which occurs as large portfolios reposition themselves, can cause the stock market to fall.
Uncertainty is the inability to predict future events. People cannot predict the size of a possible recession, when it will start/end, how much it will cost, or which companies will be able to survive it unscathed.
Most companies routinely forecast sales and production trends that investors will follow, assuming normal market conditions, but increased levels of uncertainty can make these numbers materially inaccurate.
Micro and macro risks
Uncertainty itself can affect the economy at both the micro and macro levels. Micro-level uncertainty centers around the impact on individual companies in an economy facing the threat of war or recession, while macro-level uncertainty tends to be more about the economy as a whole.
Micro risks
From a micro-level, company-specific perspective, uncertainty is a major concern for those who produce consumer products every day. For example, consumption may fall when a recession threatens as people refrain from purchasing new cars, gadgets and other necessities.
This uncertainty may force companies in certain sectors to lay off some of their employees to combat the impact of declining sales. The level of uncertainty surrounding a company's sales extends to the stock market. Consequently, stock prices of companies producing non-essential goods sometimes fall when the level of uncertainty increases.
Macro risks
At the macro level, uncertainty increases if countries at war are major suppliers or consumers of goods. A good example is a country that supplies most of the world's oil. If that country goes to war, uncertainty about the level of world oil reserves will increase. Because demand for oil will be high and supply uncertain, a country unable to produce enough oil within its borders will have to secure enough oil reserves to cover operations. As a result, the price of oil will rise.
Another macro-level event that affects companies and investors is capital flight and devaluation of exchange rates. When a country faces the threat of war or recession, its economy is considered unstable.
Investors are trying to move their currency from unstable sources to stable ones; The currency of a country under threat of war can be sold, and the currency of countries not under threat of war is bought instead. The average investor probably wouldn't do this, but large institutional investors and currency futures traders would. These actions lead to devaluation of exchange rates.
Investment strategies in uncertain times
When situations of increased uncertainty arise, the best defense is to be as informed as possible. Stay on top of news that moves markets and research individual companies. Analyze which industries have the most to gain and lose from the crisis and decide on a long-term plan.
Investing in gold has been a popular strategy during difficult economic times, primarily because gold has intrinsic value.
Times of heightened uncertainty can present great opportunities for investors who are willing to take advantage of it. Some investors may decide to go on the offensive and look for companies offering products or services that will generate greater profits when the situation changes. It's difficult to invest capital in uncertain times, but it can often yield huge returns in the long run. Those looking to mitigate uncertainty and risk may be content to leave their money where it is, or perhaps move it into safer securities.
Diversification is always a key investment tactic, not just in times of uncertainty. Spreading your investments across different assets, such as stocks, bonds and precious metals, helps soften the blow if one area depreciates quickly.
Additionally, investing in different regions, sectors and industries also increases diversification. For example, if you have all your investments in oil companies and oil prices fall due to the outbreak of war in the Middle East, you are exposed to significant risk of loss. Now, if you also had investments in the technology sector and renewable energy, your portfolio wouldn't be hit as hard.
Bottom line
Regardless of which strategy you decide to take (if any), you can't go wrong in the long run if you are well informed and can take advantage of prices when the situation changes. Being able to stay abreast of news and adjust your portfolio accordingly will help you invest wisely during uncertain times.
