Stocks actually perform better when investors are uncertain about economic policy, despite fears to the contrary, says a Wall Street chief strategist

Andrew Kelly/Reuters
Although investors have been taught to believe the stock market hates uncertainty and that they are afraid of it, historical performance shows otherwise.

According to The Leuthold Group, high levels in economic-policy uncertainty have been associated since 1985 with strong future stock returns.

James Paulsen, chief investment strategist, stated that investors who want more clarity should be cautious about what they desire.

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James Paulsen, chief investment strategist at Leuthold Group, said that investors have been taught to believe the stock market hates uncertainty. However, historical performance shows otherwise.

Paulsen recently highlighted in a client note that periods of high uncertainty about economic policy have been linked to solid future stock market returns. Paulsen believes it makes sense as many people remain uncertain about the Fed and fiscal policies long after 2008's great recession.

Investors are in a state of uncertainty as they wait to see if the Fed will reduce its monthly bond purchases and by how much, when it will raise interest rates and whether Congress will have the ability to spend as much as President Biden would like.

Paulsen used a variety of indicators to measure fiscal and monetary uncertainty and found that stock market returns were the worst when both fiscal and monetary uncertainty were lower than average. Paulsen explained that the stock market suffered when investors weren't concerned about economic policies.

The flip side is that the stock market provided future annualized returns of around 20% when fiscal or monetary policy concerns were higher than average.

We believe that high levels of policy uncertainty can lead to higher stock returns, as it creates a Wall of Worry. Paulsen stated that investors who are worried about the future actions of fiscal and monetary authorities can make the stock market more attractive than its potential downside.

This is reflected in the Wall Street adage, that the stock market rises on a wall and then falls on a slope full of hope.

"Investors looking for clarity should be cautious about what they want...rather than fearing policy uncertainty, stock traders should embrace it!" Paulsen concluded.

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The Leuthold Group