The only reason investing works is because things can go wrong

Volatility doesn’t wear a sign around its neck or call ahead. It simply arrives, in a different guise nearly every time.

Markets are unnerved this morning because of a failing bank in Portugal…

The bank’s shares tumbled more than 14 percent today and its bonds dropped to record lows. Portuguese government debt led declines among securities from Europe’s most indebted nations, while banks dragged stocks in the region down more than 1 percent.

The selloff is reawakening concern that the financial system remains vulnerable to shocks as the euro region emerges from the sovereign debt crisis. While the Portuguese government said the nation’s second-biggest lender is isolated from losses in group holding companies, lack of transparency in the corporate structure is disturbing investors.

What does this mean for the markets? What does it mean for investors?

There’s absolutely no way of knowing, there are only guesses.

What we do know for sure, however, is that the arrival of this new wrinkle in the narrative will cause some people to change their behavior or to react in different ways.

It will mean some dislocations and disturbances, sales and purchases of various securities and hedges. it will mean some reactions in other asset classes, perhaps, and plenty of commentary in the financial media firmament. It will cause some people to change their minds about some things while strengthening some of the convictions of others.

A few of those who move based on this news will get the impact right, a few will get it wrong. Some will overreact, some will wish they had reacted more quickly or forcefully or not at all. Only time will tell whether or not this event will signify nothing or everything.

But people’s mere attempt to do something – Capitalize! Protect! Anything! – is the secret to why investing works in the first place. If no one believed that anything could ever go wrong, asset prices would be permanently bid up to levels from which no gains could be reasonably expected in the future. If risk were to be permanently barred from the market, there would cease to be a market at all. Why would anyone sell anything? Why would anything trade at any sort of buyable discount? Why would any opportunities be left for us at all?

Paradoxically, a Perfect World would be nothing short of disastrous for those who require return on their invested capital. A Goldilocks environment would actually be a worst case scenario for anyone with a time horizon longer than a few hours.

Be thankful for bouts of uncertainty. Rejoice in these reminders of risk.

“The way I see it, if you want the rainbow, you gotta put up with the rain.” – Dolly Parton

Read Also:

Has the Market Correction Started?  (Bloomberg View)