Is uncertainty actually a good thing? A look at what impact it has on economic sentiment

If the world functioned according to economic forecasts, last year would have possibly have been one of the most disastrous years for the stock market and global economy since the financial crisis. Heading into Brexit and the US Presidential Election, economists were predicting economic turmoil if the UK voted to leave the EU and the US voted Trump into office. If either of these scenarios unfolded, analysts proclaimed, uncertainty would dominate the business environment putting the brakes on investment and economic growth.

These forecasts are now long forgotten and thankfully, they have, so far, proved to be incorrect. This poses an interesting question: so far despite the prevailing uncertainty around Brexit and Trump, economic growth has continued, stock markets have risen to new highs and business investment has continued. So, it seems that it is business as usual but what about the economic sentiment uncertainty? Does it no longer matter?

Economic Sentiment – Uncertainty and business planning

It is often said that uncertainty is the biggest headwind for businesses. There’s evidence to back up this claim. Indeed, the International Monetary Fund has previously estimated that a one standard deviation increase in levels of Economic Sentiment is associated with a 0.4 to 1.3 percentage point increase in output growth in that year.

According to PwC’s latest global CEO survey, uncertain economic growth was considered the biggest threat to businesses, with 30% of business leaders telling PwC they expect at least one crisis to impact their business within the next three years. So, we know the business community is worried about uncertainty but why is this not yet reflected in the hard data?

Analysts at Australian investment bank Macquarie speculate that confidence could be being propped up by the possibilities of change rather than the concern about what the changes will bring.

In a research report published last week, Macquarie’s analysts point out that they could be three main reasons behind the lack of drop in confidence. Firstly, they argue that global reflation is masking “what would ultimately prove to be negative outcomes”. Second, time could be a factor. Not enough time has yet elapsed for traditional economic models to play out. And third, (the catalyst bank believes is most likely) “ignorant households” have “failed to behave rationally”. As the report explains:

“…Normal people are not profit-maximizing and rational agents. Brexiters or leavers were clearly happy that the country is moving on and excited by its prospects outside of the EU, just as small businesses in the US are excited about investment and infrastructure opportunities that Trump administration might deliver and ‘people’ are excited that the new leadership might protect their jobs…People do not have perfect knowledge of either their surroundings or their future and as psychologists continue to highlight, even if they did, it is unlikely that most people have the processing power to make an optimum judgement…

It is therefore not surprising that political and social dislocations can lead to higher confidence, which in turn might be able to translate into real economic outcomes. In the meantime, investors are focusing on the ‘delta’ rather than absolute truths.”