Economic risk is merely average right now. I point this out to counter the many stock market analysts who have warned in their 2024 forecasts that the U.S. economy’s current risk level must be at or near a record high.
And many of you are convinced they’re right.
The analysts’ recitation of current risks will be familiar: The war in the Middle East could escalate into World War III. The Ukraine war could spiral out of control too. Then there’s the possibility of higher U.S. inflation and interest rates, along with a possible recession. The list goes on.
The problem with this narrative is in thinking that risk isn’t always high. Our psyches play tricks on us to make us think that the risks we’re facing right now are off the charts. That’s because, once we know how things turn out, we immediately rewrite history to tell ourselves that it was obvious that they would turn out the way they did.
Take the range of possible outcomes of the U.S. economy being put into the functional equivalent of a medically induced coma in the wake of the Covid-19 pandemic. Today we tell ourselves that of course the federal government and the Federal Reserve would respond with massive fiscal and monetary stimulus, and that of course the stock market would soar in response. But this was anything but obvious in advance.
We know that because of an objective measure of economic uncertainty created several years ago by finance professors Scott Baker of Northwestern University, Nick Bloom of Stanford University, and Steven Davis of the University of Chicago. Known as the Economic Policy Uncertainty index, it is based on monthly searches of 10 major U.S. newspapers “for terms related to economic and policy uncertainty” (EPU). The accompanying chart of the past four decades shows that the EPU peak in early 2020 was more than three times the current level.
Furthermore, as you can also see from the chart, current uncertainty is almost precisely equal to its four-decade average.
Compensation for risk
You may find it discouraging that current risk levels, scary though they may seem, are merely average. Remember, however, that risk is essential if the stock market is to provide future returns as impressive as those in the past. Without future risk as high as its historical average, the market’s long-term future return would be much lower. So be careful what you wish for (and careful what you complain about).
You may want the market’s return to be high and risk to be low, but you can’t have it both ways.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]
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