How Much Uncertainty Can the Market Withstand?
There’s an old Wall Street adage that markets hate uncertainty, but that idea has been challenged over the past year as stocks have rallied despite surging uncertainty on trade policy, immigration, geopolitics, and, more recently, government/corporate relationships.
But with general policy uncertainty rising/spreading, it’s worth pointing out that just because markets can stomach some uncertainty, it’s not clear it can withstand unlimited uncertainty, and it’s not unreasonable to think that policy volatility emanating from Washington could become a headwind on stocks in the coming year. In addition, the midterm elections serve up the lion's share of uncertainty this year.
Over the past year, the amount of policy uncertainty that has confronted investors and markets is the highest I have ever seen in my career. 1) U.S. trade policy was upended like we haven’t seen in decades, with dramatic changes followed by near-constant delays, revisions, threats, etc. Nearly a year later, U.S. tariff policy remains very unclear with the Supreme Court IEEPA decision looming. 2) Immigration policy was also upended, with dramatic changes that have impacted the supply of available labor, with unknown influences on inflation. 3) Geopolitics remains as unsettled as it’s been in decades, with the Russia/Ukraine war, Israel/Iran/U.S. tensions high, China/Taiwan tensions elevated, and U.S. policy shifts towards its own hemisphere (Venezuela, Mexico, Greenland, etc.). 4) Fed policy, with Trump’s prior criticism of Powell, Sunday’s announcement of a criminal investigation of Chair Powell, and concern that the next Fed Chair won’t be independent.
Last week, markets had to confront new uncertainty as government influence on industry entered the fray, as President Trump announced initiatives to 1) Ban investment firms from buying single-family homes (this hit the financials on Wednesday), followed by an announcement to 2) Limit credit card rates to 10%. Additionally, the president also threatened action against defensive companies that pay, in his opinion, too high dividends or buy back too many shares.
The various industry announcements weighed on specific sectors temporarily last week, but it wasn’t enough to pressure the entire market. However, last week’s announcements raise a new potential risk for us to consider in 2026: Government policy chaos negatively impacts business investment or earnings. Financial firms being banned from various profitable business activities would obviously be negative for earnings, while the government getting more involved in shareholder policies is also a negative.
Now, to be clear, these pronouncements last week can’t just be decreed, and many of them would have to become law, but they can still influence corporate behavior, so we need to watch that closely, especially if government influence/ involvement in the industry continues to rise. More broadly, while none of this uncertainty has impacted markets yet, I do think this is a risk we need to monitor going forward because the lack of market reaction to this policy uncertainty seems to be emboldening the administration. So far, markets have weathered it thanks to positive offset (stimulus, etc.). But at some point, uncertainty will take a toll, and while we’re not there yet, we are getting closer.
This week, I am moving most of my managed accounts to a more conservative position due to the uncertainty of the elections, but I am reinforced by the additional uncertainty that may very well affect earnings going forward. 40% in bonds should help us weather a potential storm and yet not keep us out of a market that has rewarded resilience more times than not. In addition, a larger position in value is a move to less volatile stocks.
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