Corporate Confidence Continues to Wane

I closed my review of the 2012 prospects for mergers and acquisitions with this paragraph: “Let’s hope the boom in M&A business does take place. Let’s hope that the corporate cash and corporate borrowing do not go just to corporations buying back their own stock. Let’s hope that the unwinding and restructuring takes place because that is one prerequisite for business to get back to the capital investment activities that do drive economic growth.”

(http://seekingalpha.com/article/321037-the-outlook-for-mergers-and-acquisitions-in-2012)

However, at the end of January we see the headlines: “M&A volumes at lowest for a decade.” (http://www.ft.com/intl/cms/s/0/f23718f6-4a76-11e1-8110-00144feabdc0.html#axzz1kx2Cicvs) “Dealmaking has had its slowest start to a year for nearly a decade, as companies’ appetite for mergers and acquisitions remains suppressed by the uncertain outlook for the global economy.”

The deal volumes announced so far this year…about half the level of 2011 at this time according to S&P Capital IQ.

Additionally, we read “Hordes of hoarders,” concerning corporate cash hordes…with corporate entities holding onto well over $1.7 trillion at last count. “ (http://www.ft.com/intl/cms/s/0/4cd6cb8c-48e0-11e1-974a-00144feabdc0.html#axzz1kx2Cicvs) “At present, cash accounts for more than 6 percent of US non-financial companies.”

In one specific case, Apple has almost $100 billion in cash on its balance sheet, about level with the market value of firms like McDonalds, or ConocoPhillips, or Cisco Systems.

This pales against the cash holdings of US commercial banks who in January 2012 hold almost 13 percent of their assets in cash balances, up from 9.3 percent at the end of 2010.

I know that this is early in the year, but with everyone looking for positive signs that the economy is picking up steam we need to consider other signs as well. Furthermore, the current situation is not unlike the situation that existed at the start of last year…and the actual commitments never really came about.

The one word that seems to be on almost everyone’s lips concerning this situation is…uncertainty.

There is just so much uncertainty that exists in the world right now that people are unwilling to commit substantial resources to acquisitions…or capital investments.

Where is this uncertainty coming from?

In my mind this uncertainty exists from the lack of economic leadership in the world today.  Europe continues to dither…and so does the UK…and so does the US. 

No one seems to know where they are going…or where we are going. 

How can anyone commit in such an environment?

Who knows what economic policies are going to prevail in these areas over the next year or two…let alone the next three months?

Who knows how the people in these areas are going to react to whatever economic policies are going to be enacted by their governments?

We’ve seen how the governments have acted in the recent past…and these examples cannot give anyone much confidence.

Right now, I am concentrating on factors such as these to try and understand the state of the economy.  Business leaders may be prepared to commit in the future and certainly they have the means to borrow additional funds if they need them.

These leaders still face the following question: “Why should I commit to buy another company now when the economy could get worse and I could buy the same company for a lower price at some time in the near future?” 

Right now, the probability of this happening is still apparently large enough that it is causing these business leaders to hesitate to commit on acquisitions…or capital investment. 

I keep asking people to name one person in a position of political authority in the world that they would apply the title “leader” to…and I keep coming up with silence.

Unfortunately, I don’t believe that business leaders are going to commit resources until some sort of political leadership is forthcoming. 

I still believe that we can look at how corporations are using their “cash” as an indicator of future economic performance. 

For right now, though, the “cash” stays on the balance sheets!

The uncertainty just won't go away!

This from the Financial Times on the morning of Friday, November 20, 2009: “Short-term US interest rates turned negative on Thursday as banks frantically stockpiled government securities in order to polish their balance sheets for the end of the year.” (See: http://www.ft.com/cms/s/0/52e0f72c-d575-11de-81ee-00144feabdc0.html.)

“The development highlighted the continuing distortions in the financial system more than a year after Lehman Brothers’ failure triggered a global crisis.”

“With the Federal Reserve maintaining an overnight target rate of zero to 0.25 per cent, investors are demonstrating a willingness to completely forgo interest income—or even to take a small loss—to own securities that are seen as safe.”

Just how “safe” do these banks have to appear?

The way they are acting indicate that they are not very “safe” at all.

Total reserves at depository institutions for the two weeks ending November 18 averaged $1,106 billion of which $1,068 were reserve balances with Federal Reserve Banks and $38 billion was vault cash used to satisfy required reserves.

The Fed has pumped roughly $350 billion into the banking system over the past 13-weeks primarily through the purchase of open market securities.

The effective Federal Funds rate has fallen steadily through the fall from August and averaged 11 basis points toward the end of the latest banking week.

Putting this information together indicates, to me, a banking system that is still seriously threatened and desirous of all the spare cash that it can attain. This is not a situation of quantitative easing but of bankers that are overly concerned with their solvency. The Federal Reserve is supplying reserves “on demand.” They are not, at this time, initiating the supply.

And, why might this be so?

Well, take a look at some of the headlines of the past week: United States mortgage delinquencies reach a record high; bankruptcies continue to remain near record levels; commercial real estate to remain major problem for years; commercial real estate too complex for government to bail out; unemployment at 25-year high; credit card delinquencies remain at record levels; and bank failures will continue to average about 3 a week for the next 12 to 18 months.

President Obama is even talking about the possibility of a “double-dip” recession.

The distortions in the financial system continue to be enormous. Even given these attitudes within the banking system, as the Financial Times reports, “many” of the leading US banks are “sitting on big trading profits.”

And, why not? When they can borrow for less than 35 basis points and lend out at 350 basis points who cannot make profits. When they can engage in the “carry” trade and profit from the declining dollar as well as earn large spreads, who cannot make profits.

Stock markets have been living off of momentum trading. There are so many unknowns about the future of business and industry, let alone finance that the justification for the rise in stock prices since March can continue to be questioned.

The real problem that exists in the market right now is the huge overhang of uncertainty. Not only are there unknowns about the recovery of industry and finance right now, there are also unknowns related to the huge cloud of government budget deficits that hang over the financial markets for the future and the concern over the ability of the Federal Reserve to “exit” from all the reserves it has put into the banking system.

The risk that is incorporated in this environment shows itself from time-to-time. Of course, the massive rise in the price of gold has been one place that investors have flocked to this year. Another continues to be the world-wide demand for United States Treasury securities. And, like yesterday, enough bad news causes currency traders to move rapidly back into United States dollars for “reasons of safety.”

I know many measures of market risk have declined substantially over the past six months or so. One has to go back to November 2007 to see a spread between Aaa and Baa yields as low as they are now. Likewise, with spreads on high-yield securities. The VIX index has fallen, once again, around its 52-week low. My belief is that these measures are so low because of the Fed’s interest rate policy. Interest rates, in general, are lower than they would be if the Fed was not forcing low rates on the market, and interest rate spreads are low for the same reason.

Still, there is much to be wary of. The only certainty that exists right now is that the Federal Reserve, and other central banks around the world, will keep short term interest rates low for an “extended period.” But, at some point, these rates are going to have to rise. Until they do, the interest arbitrage opportunities will remain and large financial institutions will continue to take away large profits from the financial market. Furthermore, the carry trade will continue to prosper using funds from the United States.

The question here is, when will all the investors that are “making it” through government support and government guarantees head for the doors. It is only logical that when there is an indication that the Federal Reserve is going to start letting interest rates rise that there will be a rush to get out of the market or move to the other side of the market. In such a situation, the financial firms that are big in the trading area cannot afford to be second or third getting to the door to pull their own exit.

How will this leave the banks that are written about in the Financial Times? If these banks, generally the smaller ones, have “stockpiled” government securities, how will they handle the decline in the prices of these securities once interest rates begin to rise? If they are concerned about their solvency now, what will their condition look like under this kind of scenario?

If there is a rush to get out of bonds, will the Federal Reserve back off its exit strategy?

Uncertainty continues to rule the markets. And, on top of the basic market insecurity, there seems to be a growing insecurity about our governmental leaders (Geithner and Bernanke to start with), and about the institutions of our government (see House attack on secrecy in the Federal Reserve). Uncertainty is bad enough but if people have little or no confidence in our leaders and our institutions where are they to turn?

Uncertainty: The King of the Market and what to do about it

This is a time that is particularly conducive to impulsive or instinctive behavior. It is a time that behavioral economists love because it proves their case about irrational human behavior. People react and they react on the basis of a gut feeling or a snap judgment.

These researchers tell us that this type of behavior is what has helped the human species survive. However, it is not necessarily the kind of behavior that leads to decisions or actions that are in our best interest when investing. “Relying only on intuition in finance can lead to very bad outcomes, not only for individuals but also for markets.” (This quote comes from David Adler’s new book “Snap Judgment”: see my post that reviews this book, http://seekingalpha.com/article/145660-book-review-snap-judgment-by-david-e-adler.) Yet we humans, individually and collectively continue to perform in this way.

Right now, the concern is whether or not the economy is bottoming out and starting to recover. We get “green shoots” here, but then some other indicator of economic activity comes in worse than expected. Alcoa puts up better than expected loss numbers but retail sales come in lower than expected. Sales of existing homes improve yet we get wind of another wave of subprime mortgage problems. (See “Subprime Returns as Housing Woe,” http://online.wsj.com/article/SB124709571378614945.html#mod=todays_us_money_and_investing.) And, what about the problems in commercial real estate, credit cards, and Alt A mortgages?

Then there is the question about whether or not there should be a second round stimulus bill. Paul Krugman has argued for a long time that the first stimulus bill was not enough. Yesterday Laura Tyson indicated that she thought that there needed to be a second round. Now the debate is all over the place. But, wouldn’t another stimulus bill add more to the government budget deficit going forward? And, there are questions about the possibility that the government has already committed to too much debt.

So the Dow Jones average goes up from 6500 and looks very strong approaching 9000 and then goes into a swoon. The price of crude oil was approaching $40 a barrel in February and then shot up to above $70 but now has returned to the $60 range. The yield on the 10-year treasury issue was nearing 2.00% in December 2008, jumped up to around 3.90% in the middle of June and traded at 3.30% yesterday. An index relating the value of the dollar against major currencies was around 70 in July 2008, popped up to the mid-80s in March 2009 and has since declined to about 77.

When the economic indicators seem strong the price of oil goes up as does the stock market and the price of bonds and the value of the dollar decline. When the economy seems weaker we get just the opposite movements. And, my bet is that it is going to continue this way for a while. So, uncertainty, and hence volatility, rule the marketplace.

This is the short run. Recently, however, I have been writing more upon the long run, what deficits do to long term interest rates and to the value of the dollar. Over the longer run, historically, some patterns repeat themselves over and over again. This, of course, brings to mind the statement made by John Maynard Keynes, “In the long run we are all dead!” Still, we need to take the long run into account.

This is where we need to take heed of what the behavioral economists advise. We, as investors, must not rely on intuition or gut reactions. We must not over react to the environment we now find ourselves in. Research has shown that acting in this way is not necessarily in our best interest.

The research also indicates that investing based on fundamental economic reasoning does work. Therefore, it seems as if now is a time for discipline and hard work. And, it is a time for patience.

But, this does not mean that one needs to totally ignore the short run. It is perhaps impossible to expect that most people will just sit out this stage of the economic cycle and invest their funds in safe, low-yielding assets. So, what kind of strategy might work here? My suggestion is that one needs to segment one’s portfolio, allocating some money to playing in the current market volatility, but allocating a larger share of the funds to potential future fundamental investment choices.

The smaller part of the portfolio can be allocated to playing both sides of various markets. Obviously, getting into the market near a “bottom” would be very profitable, but selling short near a “top” would also work. But, by all means consider any investments here as short term in nature because it is highly likely that the “bottom” may not turn out to be a “bottom” at all. Likewise for a “top.” So, one must be very agile in investing this way. Don’t hang onto losses, but let gains ride. Behavioral finance tells us that people tend to operate in the opposite way hanging onto losses hoping for the best and quickly selling gains to have something to show for their efforts. This is where discipline and focus are crucial.

Furthermore, remember that, on average, the expected returns on trading are zero: and there are still fees that need to be paid. But, using part of your funds in this way keeps you “playing the game” while still keeping the major part of your portfolio available for “value” investing to take advantage of longer run opportunities.

As research has shown, the fundamentals do apply over longer periods of time. Perhaps, however, it is not quite time to commit to some of these “value” propositions. People are worried about the potential inflation that may come about due to the large government budget deficits and the possibility that the Federal Reserve will have to monetize a substantial amount of the debt created. But, there are many people who think that deflation is going to be more of an issue in the near term. Hence, it is perhaps a little premature to put funds into investments that will prosper from a future period of high inflation. This part of the portfolio should be kept safe, but also should be able to be accessed when the time is right to commit to the longer run fundamentals. Research, however, has shown that it is alright to be a little early on these types of investments because the possible returns on such a commitment to fundamentals are substantial enough that being a little early is not harmful.

It is also important that an investor should stay in the areas of the market that they know best. If your skills lend themselves to the technology sector of the stock market then stay there. If your skills are in the government bond market then stay there. If your skills are in the foreign exchange market then stay there. Again, discipline and focus are all important.

Uncertainty is going to remain with us for quite some time in financial markets and commodity markets. The behavioral economists have warned us that this is a dangerous time to act in just an impulsive or instinctive manner. So, if being methodical is not your “cup of tea” then beware for the statistics are not with you. Chasing every “green shoot” or market reaction is not going to produce happy results. Acting in a focused and disciplined way may be very difficult for us to achieve but we need to try. That is what humans have learned they must do in activities like investing in financial or commodity markets.

Uncertainty and the Economy: Some Comments

In this post I attempt to respond to some comments that were written concerning my post of August 25. (http://seekingalpha.com/article/92648-the-reign-of-uncertainty-in-financial-markets) The comments specifically related to the fact that uncertainty always exists and whether or not markets work. I wrote the post of August 25 because I believe that uncertainty is greater now than it has been for a very long time. As a consequence, the volatility of markets is extreme and will continue to be extreme as long as this level of uncertainty continues to exist. I believe that this should be a consideration in the current business and investment decisions being made.

Uncertainty exists because humans make decisions based upon incomplete information. That is, if a decision maker had complete information there would be no uncertainty about what action that individual should take because the decision maker would know precisely the outcome that would result from any action that was available. The decision maker would, therefore, take the action that would be the ‘best’ in terms of the outcome that is being sought.

Uncertainty is defined in terms of variance. That is, because a decision maker has only incomplete information to work with, he/she will not know before the decision is made exactly what the outcome of that decision will be. Usually, there is a range of possible outcomes that can occur given the choice of a particular decision. Uncertainty, therefore, is relative in the sense that a situation in which the range of possible outcomes is somewhat narrow would be considered to be less risky than a situation in which the range of possible outcomes was much broader.

Generally one argues that if the decision maker has less information, the range of possible outcomes will be greater than if there is more information available. With less information available and a consequently larger range of possible outcomes, the situation is said to be riskier than when the decision maker has more information and a resultant narrower range of possible outcomes.

Therefore, to add to my post of August 25 I would state that we are currently working with less information relative to the possible outcomes that we have to deal with than we have in quite some time. From this I infer that in the current environment that businesses and investors are facing greater risk relative to their decisions than they have in a long time. And, as a consequence of this greater risk I would argue that markets will continue to be more volatile in the foreseeable future than they have been in recent history.

There is another issue that is being stressed relative to the current uncertainty. Nassim Nicholas Teleb, in his book “The Black Swan”, writes about two kinds of situations in which a decision maker has incomplete information. The first is what most people are more familiar with. This is a situation which uses the historical information available to create statistics that people can use to make better decisions. These statistics include probability distributions, means, standard deviations, and so on. These statistics can be used in routine, repeatable cases of decision making to help the decision maker incorporate what he or she does not know into their decision making process. Gathering more information in these situations help us to refine the probability distribution related to the specific case under review and its attributes.

The second type of situation, the one that Taleb is most interested in presenting to us, depends upon what we don’t know. That is, this kind of decision does not lend itself to the use of ordinary statistical analysis because these decisions relate to situations in which we have little or no experience relating to the information we don’t know, hence nothing to guide us in our decision making. Taleb tells of the turkey being fattened up to become a Thanksgiving dinner. For 1000 days the turkey is fed very well and treated like royalty. The 1001st day, the turkey is prepared for the Thanksgiving dinner. If the only information one has is the information from the first 1000 days, the prediction for the 1001st day would be to be fed very well and to be treated like royalty. Gathering more of the same kind of information helps very little. What is needed is not known and unless one knows what types of information are missing one can gain little to help in improving one’s ability to make a prediction.

In terms of this latter type of uncertainty, one can argue that in the current situation we don’t know what questions we should be asking or what kinds of information we need. In Taleb’s terms we are in the arena of the Black Swan.

Another question has been asked about whether or not I believe that markets work. The answer to this is yes, I believe that markets work and I have long argued that one must be careful in interfering with markets because, even though the intent of the person wanting to interfere with the working of the market may be the very best, humans, by and large have done much damage to markets, and to people, by interfering with the workings of markets. If one fusses around with markets, one must be very careful, and one must attempt to work with the processes related to markets and not to the outcomes achieved by markets.

Still, I believe that it is necessary to work with markets in order to help the markets function. There are many reasons for this. One of them has to do with incomplete information and the fact that some participants in markets may have more information than other participants do. Also, the existence of asymmetric information in markets in the short run can result in things like a liquidity crises that can cumulate in a dramatic downward spiral of prices. Another reason has to do with the existence of transaction costs and the fact that due to the existence of transaction costs markets may not function as efficiently and effectively as they could, especially with respect to the time it takes for the market to work out of a disruptive situation. Furthermore, incentives can exist that lead to behavior that is dishonest and harmful to others. Human beings are vulnerable to such incentives when the apparent marginal benefit of cheating seems to exceed the marginal cost of getting caught cheating.

Human beings are problem solvers and when they see situations that have seemingly undesirable consequences they attempt to fix them. This characteristic of human beings is what makes them especially unique among living species. It is a characteristic that has substantial survival value. But, humans must be careful when attempting to apply their problem solving skills to markets. First, as I mentioned above, in working with markets, humans need to focus on processes and not outcomes. They need to focus on rules about how individuals are to perform…such as rules pertaining to the importance of full disclosure and openness…and not what results they attain…such as the amount of people that someone hires. This cannot always be done, but it is a methodology that should be strived for.

Second, the crucial issue always has to do with the balance of interference that is achieved. My belief is that humans are always going to try and make things better…help markets operate more efficiently…and so it is a question of the balance between the two extreme goals that is important. If has always been my practice to try and err on the side of less interference with markets than more interference. Furthermore, it is always the case that this balance will change with time as we learn more and as the market adjusts to any interference imposed.

Dubner and Levitt state very clearly in “Freakonomics” that anytime any kind of incentive system (rules and regulations) is set up, there will be numerous people attempting to take advantage of the new system. This, to me, is another major argument for minimizing interference in markets…interference causes people to focus on beating the new rules and regulations imposed on the market. Thus, any new rules and regulations that are set up need to minimize the payoff for beating the new system so that more people keep their focus on making the market work rather than taking advantage of the new system. The more restrictive or the greater the interference of any new rules and regulations the more benefit that can be gained from “breaking” the system. Thus, I feel that there will be interferences with markets…with the best of intentions…but extreme care must be taken when interferences are imposed.

I hope these responses help readers understand a little bit more of where I am coming from.

Markets and Uncertainty

This is not the best time to be recommending books to people. But, I thought that, given all the turmoil around, it would be worthwhile for us to remember some relatively recent works that might help us to regain some perspective on markets (financial and otherwise) and guide us back to the fundamental issues we have to deal with during times like these. It is all too easy to get caught up in personalities or specific situations and that, in my mind, is exactly what we don’t want to do. For example, Paul Krugman’s Op-ed piece in the New York Times on March 10, 2008, is an example of emotional reporting and needs to be tempered with a review of the basics on which market participants need to concentrate: http://www.nytimes.com/2008/03/10/opinion/10krugman.html?hp.

I have great admiration for former Treasury Secretary Robert Rubin and have found his book (written with Jacob Weisberg) titled “In An Uncertain World: Tough Choices From Wall Street to Washington (Random House: 2004) to be helpful in the sense that Rubin has apparently systematically applied the techniques of decision making under uncertainty to both business and governmental situations. (I, like a lot of other people, are waiting for his next book in which he will discuss his role in the recent events at Citibank.) In terms of dealing with uncertainty there are two important ‘take-aways’ from this book. The first is that uncertainty in pervasive in human decision making. The thing that differentiates one situation from another is whether greater uncertainty or less uncertainty applies. The second pertains to the methodology used: the decision maker must be try to identify all of the possible outcomes related to the decisions that are available to her or him; and the decision maker must, in some way, assign probabilities to each of the possible outcomes.

Of course, the methodology that Rubin proposes is not an easy one to apply, particularly when one is under stress and is having to deal with markets that can move quite rapidly. Difficulty, however, is no excuse for not attempting, even in a simple way, to deal with the uncertainty that the individual is facing. We must do our research, we must read a lot and listen to many different opinions, and we must then make the best effort we can. There are no objective criteria for determining a comprehensive list of possible outcomes and the probabilities to assign to each outcome: everything is ‘subjective’. Intuition and experience are important factors alongside knowledge and skill.

Another book that is helpful in understanding the process of decision making under conditions of uncertainty is that of Michael J. Mauboussin titled “More Than You Know” (Columbia University Press, Updated Expanded Edition: 2007). There are several ‘take-aways’ from this book that should be remembered in dealing with uncertain markets. One of the first is that people tend to consider too narrow a range of potential outcomes. Thus, it is always relevant for people to expand their perspective and give attention to the possible outcomes they might otherwise exclude. It is a good discipline to force yourself to consider outcomes that you think only have a small probability of occurring. In doing so, you protect yourself from unintentionally eliminating outcomes that you might ordinarily dismiss from careful consideration.

A second thing that Mauboussin discusses which might be important in our analysis of uncertain situations is that all analysts and commentators will not be correct all of the time. Thus, we must not rely on one or just a few individuals for their view of the market. However, we should pay more attention to those analysts and commentators that have a higher ‘batting average’ than others. Even though we know that all will be wrong some of the time, those with a higher’ batting average’ will tend to have more ‘streaks’ of being right and longer ‘streaks’ than those whose ‘batting average’ is much lower. Thus, there are some analysts and commentators we should review more than others even though we know that they will be wrong a fair percentage of the time.

A third relevant factor is that individuals, according to the research that Mauboussin cites, do not always act in a completely rational way. For example, they may weigh possible losses more heavily than gains in their decision making. However, even though individual participants in the market may not be completely rational, if these participants generally act independently of one another, markets will ‘tend’ to be priced appropriately. This is because that, when aggregated into the whole market, the deficiencies of the individual decision makers seem to cancel out and the resulting prices tend to be a relatively adequate reflection of all the information that is available to the market at that time.

The time when this will not be true is when individuals do not behave independently of one another. At these times, the market becomes unbalanced because opinion tends to congregate on the buy side of the market or on the sell side and people act more like a ‘herd’ than independent individual decision makers. These are the times when the markets become ‘disorderly’ and present the greatest problem to policy makers. We have given special names to some of these disorderly situations such as ‘liquidity crisis’ or ‘credit crisis’ or ‘market collapse’.

There are two other books on markets and uncertainty that provide a good deal of insight into the world of decision making under uncertainty. Both of the books are by Nassim Nicholas Taleb: the first of these is titled “Fooled by Randomness” (Random House, 2005); and the second is “The Black Swan: The Impact of the Highly Improbable” (Random House, 2007). Both of these books contribute to our understanding of the point made by Robert Rubin that there are, at most, only a limited number of situations in life that are not subject to uncertainty. Uncertainty comes from not having all the information we need in order to make a decision or to solve a problem. The idea that we have complete information on every situation we face in life is just a fantasy. The tendency to narrow the range of possible outcomes we consider in any specific case is related to our desire for greater certainty in life: humans tend to act as if they had complete information. Taleb presents us with example after example of the absence of complete information in our decision making or problem solving.

One additional fact is emphasized by both Mauboussin and Taleb: the probability distributions that apply to most uncertain market situations are not normal distributions. Although the probability distributions used should all conform to the general rules of probability theory, it has been shown that the tails of these probability distributions are ‘fatter’ than those of a normal distribution. That is, extreme events should have more probability assigned to them than would be the case if the probability distributions were normally constructed. Thus, these extreme events may not be very probable, but the expected impact of their occurring can be more substantial than might be thought. This conclusion is not meant to frighten, but only to serve as one more piece of information that will help us to understand the performance of the markets in which we operate.

Recently in a talk, Federal Reserve Governor Fred Mishkin indicated how uncertainty can impact price relationships within a market. The case that Mishkin discussed related to the calculation of inflationary expectations measured by the difference between the yield on the10-year Treasury bond and the yield on the 10-year inflation protected Treasury securities, TIPS. This differential has been increasing since the first of the year and the general interpretation given the increase is that financial market participants now expect more inflation over the next 10 years than they had expected last fall. Mishkin argued that the increase in this differential was not due to an increase in inflationary expectations but was due to an increase in the ‘uncertainty’ of what inflation will be. In this respect, uncertainty can affect markets. But, we must deal with uncertainty as analytically as possible, for that is the best way to make decisions because it tempers the impact of the more dramatic events that we generally see in the headlines.