The Hour Between Dog and Wolf

Imagine you're walking back to your share crop in Normandy during the Middle Ages. It's dusk. Soft, hazy light rakes the landscape. You walk across fields silhouetted with trees, returning from hedging this year's onion crop in town — selling futures. You look out across your field and wonder "hm, is that shadowy animal a dog or wolf?"

Then you'd be eaten because, obviously, it was a wolf and you've already way overshot the expected life span for the era. At your wake, friends lament "entre chien et loup" — "between dog and wolf." The phrase describes the subtle uncertainty and risk that dusk brings. And, being French, it's much more romantic than just saying "things look a little fuzzy when the light's bad."

Time passes

Neuroscientist and Wall Street refugee John Coates uses the phrase to frame what happens to humans under stress. Traders transform from puppies to animals and back. It's physical and chemical.

This is useful to keep in mind. We — investors — come to the market each day. Markets are uncertain. Prices move up. Prices move down. Is a down move the beginning of being eaten by a wolf or is this market just a puppy?

Volatility has been marching up all year. The US and Israel's invasion of Iran sent volatility heading towards crisis levels. This, though, isn't about the US and Israel's war on Iran. It's more generally about what to do when the market suddenly perceives higher uncertainty.

The market isn't supposed to vote on whether wars are bad. That's not how it works in the wild. Do you remember what happened to the S&P when Iraq invaded Kuwait in 1990? Probably not. It dropped about 20%, then recovered the next year. How about the next time the US invaded Iraq in 2003? Don't remember the market reaction there either, huh. It dropped 14% but was up for the year.

To be clear: wars are bad. It's just not the market's job to reflect that badness. Some companies certainly look to take a hit — airlines, agriculture. But markets and the companies that make up those markets are adaptable. While everyone’s share price gets trashed in a crisis, not everyone’s business is impacted the same. Investors can find opportunities in companies whose investment case won’t be made or broken by the war on Iran — companies maybe like ones that design semiconductors, ones that run internet forums, ones that sell gaming consoles and others. The market’s perception of uncertainty is a feature of the market that provides investment opportunities.

Evolution

Given enough time and good behavior, wolves domesticated into dogs. Investors usually don't have to wait the tens of thousands of years it took for that to happen for markets to reward good behavior. Investors can use the markets’ perception of uncertainty as a dial for finding opportunity and managing risk. When the market’s certain of good times lasting, we can tighten the dial. We can open it up a bit if we've prepared and the market suddenly sees far more uncertainty.

Disclaimer: None of this is investment advice. It's meant to illustrate ways LCM thinks about investing. Things that LCM decides are good investments for LCM and its clients are based on many criteria, not all of which are covered here. Some or all of LCM's ideas may not be suitable for other investors. LCM does not recommend investing either long or short any position mentioned. LCM may own positions in some of the companies mentioned. Some of its ideas will lose money — investing entails risk. See full disclaimer here.