I’ve discussed in other blogs why the stock market ‘always comes back’ after a crash or severe correction. This eventual rebound is pretty much known and accepted by investors. What is not known, is how long each individual bear market will last, and when the rebound will occur. It is this uncertainty that causes all the angst and fear. Will we have enough time to recoup what was lost, and can we wait, for who know how long? Heisenberg’s “uncertainty principle”, perhaps the most famous in quantum physics, says that we can never predict precisely where an atom will be at any point in time, even though atoms are easily seen with an electron microscope. Why is this so? Because the photons of light bouncing off the atoms actually change the position of the atoms. So we can never know where the atom would have been (and where it may be in the future) because shining a light on them is the only way we have to view them. Surprisingly, this paradox of quantum physics is responsible for many advancements in science and technology.
The stock market has it’s own ‘uncertainty principle’. Instead of a beam of light from an electron microscope, we have tens of thousands of beams of light all hitting the market at the same time in the form of different market opinion affecting market price. We can never know precisely how much these countless opinions acted upon, actually affect true market value. When too much positive light shines, in the form of irrational exuberance, or too many (let’s call them) negative photons, causing extreme levels of pessimism, it becomes much more difficult to predict near term future stock market prices.
But is this stock market uncertainty necessarily bad? Let’s think about it. If we knew that every bear market would directly follow the average for the last eighty years or so, and start it’s subsequent upward trajectory in exactly eighteen months, wouldn’t bubbles be extended beyond their historical high points. The result would be the opposite of Heisenberg’s uncertainty principle. If investors knew, without question, they would start to be made whole again, after each bear market, in no more than a year and a half (and could take that time limit to the bank), far fewer would sell at the beginning of any apparent crash or correction.
That would mean the typical stock market crash would never occur… until it finally did. Before this hyper-crash occurred, the typical stock market bubble could be magnified tenfold as investors held on through thick and (non-existent) thin. This, of course would eventually result in a very dangerous situation, as markets would become even more wildly overvalued than the worst stock market bubbles in history, before they were pricked. Investors would fight each other for even higher ‘greater fool’ status, as they gleefully embraced apparent financial certainty. The future would be guaranteed!- until it wasn’t. At some point, all those happy secure investors, believing “this time it’s different”, would suspect, probably all at one time, that ‘this is just another bubble’. And the mad rush to the exits would begin.
So, it turns out, counter-intuitively, that expected uncertainty in the stock market is probably very important to avoid much more extreme crashes and bubbles. Imagine that.