Friday, July 18, 2014

Pricing In Geopolitical Uncertainty

This article makes quite a bit of sense when it comes to things like the downing of the Malaysian Airlines jet and the invasion of Gaza by the Israelis.

In a repricing of risk scenario, we start to see good news ignored and people less willing to pay a higher multiple for stocks – even when they’ve announced results or initiatives that would clearly deserve it. Our inability to become excited by great news or fresh developments becomes evident in this way only over time. The inner monologue goes something like this: “Wow, I’m really impressed that Chipotle just shocked The Street with double-digit same store comps this month…but, my god, 300 passengers on a civilian airline were just shot out of the sky over Eastern Europe!” That extra lot of shares simply doesn’t get bought. People become resigned to hold what exposure they already have until “all that uncertainty dies down.” Obviously, the media plays a major role in this phenomenon, feeding it around the clock on screens everywhere. Don’t be mad, it’s kind of their job.

I have seen this repricing risk scenario over and over when it comes to things that are not as shattering as 9/11. People freak out due to "uncertainty" and stop buying on good news but sell momentum stocks on bad news. The only think concrete that might hurt the American consumer would be higher gas prices due to sanctions. Most airlines will now avoid the Ukraine and may need to use more fuel but nothing that would hurt them long-term. You would figure that the vast majority of companies as well as American and European consumers will not be affected materially.

However the fear factor caused by the event which is compounded by the 24 hour news cycle (as this article points out) usually casts a pall over the markets until something wakes it up. So if and when we get a cease-fire between the Ukraine and Russia we will see the market go back to normal. For whatever reason the market rallied today so maybe even that bit of wisdom is off the mark.

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