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How Uncertainty Damages Markets

Article by Robert Asahina May 28, 2013 //   2 minute read

Fear and greed: To most financial advisers, not much more is required to explain the behavior of investors. As Amity Shlaes notes in Forbes, financial markets are typically explained in "markets only" terms, as if investing were "a sterile experiment, with investors starring in the role of rodent."

What this kind of explanation leaves out is investor uncertainty resulting from political decisions, policies and policy-makers, rules and regulations. Shlaes notes that a new index, the Economic Policy Uncertainty Index, created by Scott R. Baker and Nicholas Bloom of Stanford and Steven J. Davis of the University of Chicago, "attempts to assess the possibility that action by politicians may do damage, even when the politicians mean well."

The EPU attempts to measure uncertainty by tracking taxes that expire, temporary tax cuts ("stimulus"), and even news events such as elections and wars.

What does this mean for investors? Shlaes writes, "political moderates and political stalemate may be better for portfolios than rule by more extreme leaders."

Read more here.