Coping with uncertainty is at the heart of every investment decision. How investors deal with uncertainty is influenced by the interplay between their conviction level when forming views, the nature of the uncertainty and their decision horizon. It is highly likely that elevated uncertainty shortens the investment horizon: when investors don’t have strong opinions, they will probably adopt a short-term approach (or simply do nothing). Even those with strong views about the medium run -e.g. the risk of recession, which would weigh on equity markets- may opt for a short-term approach when the short-term driver -e.g. getting closer to the peak in policy rates- works in the opposite direction. Such short-termism creates a risk of overshooting and an extreme compression of risk premia as well as a prospect of heightened volatility when the dominant influence shifts from the terminal rate to mounting growth fears.
