It's what you don't know that matters...

According to recent behavioral studies, humans have a very hard time coping with uncertainty. Although it is true that the economic crisis that has swept across the globe has left many households significantly poorer than they were less than two years ago, it is apparently not the reason behind the sharp drop in all kinds of "health and well being" indexes. Instead, the culprit seems to be the significant amount of uncertainty regarding the way the economy is likely to unfold over the next couple of months or years. Studies show, for example, that we tend to derive greater comfort and cope better with the certainty of bad news than with not knowing if results will be good or bad. This has something to do with the concept of "synthetic happiness" which was thought up by Harvard professor Daniel Gilbert. According to the theory, we end up being less happy when we are given a choice than when something is imposed on us. This concept was demonstrated with students that were broken into two groups. The first group were asked to rank a series of Monnet paintings in terms of attractiveness and given the chance to select the one they liked most to take with them. The second group were asked to do exactly the same thing with the exception that they were allowed to exchange their painting for another one in a week's time. At the end of a week it was discovered that the first group (who could not exchange their painting) where generally much more satisfied with their choice than the second group who had the option of exchanging it for another. In other words, choice, it seems brews dissatisfaction just as uncertainty leads to anxiety.

Is this rally for real?

Since around the 10th of March, the stock market has been rallying, generating an impressive performance of around 30% for the MSCI All Country World Index and, in the process, wiping out all the losses that had been accrued until now. The burning thought in most investors minds is if the bull run is a signal that the economy is out of the woods or if it is just another bear market rally, similar to the 5 that preceded it since the crisis began.

If we dig deeper by looking at sector performances, the markets seem to be suggesting that the recession may be entering its final phase. So far this year, the cyclical sectors, such as materials, consumer discretionary and information technology have significantly outperformed typically defensive sectors such as consumer staples, healthcare and utilities. It should be mentioned that the stock market is far from perfect as a leading indicator of the economy and that the current rally may just be reflecting a growing sense of optimism due to economic releases that are showing signs of improvement. Improvement does not necessarily mean that things are getting better, however. In the current context, it simply means that the deterioration is occurring at a slower pace. As a result, I would advise caution against the complacency that seems to be building up.