Curmi & Partners

The Perseverance of Uncertainty

By Noelle Micallef

The COVID-19 shock has challenged the world’s health care system, economies, social life and job security in ways that most of us could have scarcely imagined pre-2020. So many questions have been asked: when and how the virus will be tamed; when will social distancing measures be relaxed; what will the effects of the lockdown on consumer confidence and general wellbeing be; and obviously, how the economy will be impacted by the pandemic, and how it will evolve in response to the shock. There is a great lack of clarity, but one thing that we have learnt over the years is that “there will always be something”.

Economist Frank Knight made a clear distinction between risk and uncertainty shortly after the 1918 flu pandemic. The future is unknowable, but risk is measurable. The latter can be estimated via data, provided similar situations have happened before. On the other hand, uncertainty deals with outcomes we cannot predict or never saw coming. Whilst risk can be managed, uncertainty makes it difficult to weigh costs and benefits. Managing uncertainty is expensive – it means maintaining cash and shutting down society. Although public health experts had been warning about pandemics for years, COVID-19 was unexpected and shocked everyone. What made things worse was that there were a lot of unknowns about the novel virus – how it affects people from different generations, the quantity of asymptotic patients, true hospitalizations and death rates and most importantly, how infectious it is. What happened in previous pandemics is not particularly instructive as the virus itself, the healthcare system, and the world are very different to how they were in previous pandemics. Over the past months, more information has been discovered about the virus, the way its spread and prevented; however there is still a lot which is unknown and this may lead us to continue taking drastic action to limit the spread whilst managing the risk at a limited cost to both society and the economy.

Policymakers worldwide have tried to react in a swift manner to limit the uncertainty and influence expectations in the future. In such conditions, it is crucial that the authorities demonstrate that macroeconomic policies are under control, to try and provide a stimulus to the economy when everything is in such destress. Stock markets around the world have experienced extreme volatility. Investors had to endure steep price declines, quickly followed by strong rallies. Despite a degree of optimism over the outlook for corporate profits and an improving economic backdrop, the CBOE Volatility Index, which tracks future expectations of volatility in the S&P 500, shot to levels last seen in late 2008 in the darkest days of the financial crisis. The first quarter of 2020 saw a steep sell-off across markets, however, the S&P 500 has delivered the best third quarter performance since 2010.

In general, stocks are riskier assets to invest in than risk-free assets, and therefore investors command a premium when investing in such assets. The pandemic has further increased the market’s level of risk aversion. However, it should be noted that additional risk is a constant and inevitable in stock markets. Each month, Bank of America gathers data from global managers to obtain opinions on matters concerning the market. The chart below graphically shows the “biggest tail risk” month by month since August 2011. The reality is that history is riddled with several worrisome events, and yet, the stock market has always managed to recover. Whereas investors were concerned about who will win the Presidential elections in the beginning of 2020, COVID-19 uncertainty was the top tail risk for six straight months beginning in March. Investors should approach the upcoming one to two years as a period of higher risk than normal. According to DataTrek data going back thirty years, volatility can take months or even years to return to more average levels following a crisis.

Figure 1: Evolution of Global Fund Manager Survey "biggest tail risk"; Source: BofA Global Fund Manager Survey

Back in 2008, during the Global financial crisis, Warren Buffet stated: “In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497”. Although investors should remain cautious in such periods of high uncertainty, they should gather as much data as possible to calculate the risk that they are willing to tolerate, and seize any opportunities they observe, because uncertainty is inevitable.


The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.