Risk, Uncertainty, and Profit

By Mike Petrino, Senior PM, Market Historian for Affinity

Most metrics used to form expectations about future stock-market performance point to a volatile outlook. The trailing twelve-month Price/Earnings Ratio (P/E) is roughly 30x, well above the long-term average of about 18x. The largest seven stocks—NVIDIA, Microsoft, Meta Platforms, Alphabet, Apple, and Amazon—now constitute nearly 37% of the Index on a capitalization-weighted basis. These companies, concentrated in the technology sector, trade at P/Es above 50x on average. Their elevated valuations reflect expectations for rapid and uninterrupted earnings growth, expectations that depend heavily on continued, large-scale adoption of Artificial Intelligence (AI) by end users.

These seven stocks have dominated market performance throughout 2025. Over the first ten months of the year, the S&P 500 Index returned approximately 16.3%. Without the contribution from the “Magnificent Seven,” the return would have been closer to 7.0%. Moreover, many holders of these stocks—popularized by commentators and pundits—appear to have limited understanding of the technologies underpinning earnings growth. As a result, these shares are in relatively weak hands.

The market is therefore positioned to react severely to any disappointments, and the policy environment unfortunately sets the stage for such disappointments. Fiscal policy, in particular, remains a primary source of economic instability. The Trump Administration’s ongoing adjustments to tariffs in pursuit of more favorable trading terms effectively create on-again, off-again changes in tax rates. Higher tariffs on imported goods function as tax increases; lower tariffs function as tax reductions for U.S. businesses and consumers.

In addition, Congress remains unable to pass a budget that restrains spending growth while adequately funding essential government functions. The 43-day federal government shutdown—the longest on record—only reinforced concerns that future shutdowns may not be avoided. That episode resulted in disruptions to air travel and missed paydays for federal workers.

Monetary conditions add a further layer of complexity. The Federal Reserve is supplying more than enough liquidity to support economic growth despite inflation remaining above the 2% target. The latest year-over-year growth rate of M2 was around 4%, a pace that would, over time, sustain inflation above the Fed’s desired level. If economic growth slows because of suboptimal fiscal choices, inflation is likely to accelerate in the near term. The most recent CPI reading was slightly above 3%, and inflation has drifted higher since April 2025. As such, the market’s constant focus on potential Fed Funds rate cuts is misplaced; liquidity is already ample.

Meanwhile, the broader economy has shown signs of fatigue. Unemployment has risen from 4.0% at the start of 2025 to roughly 4.4% today. Industrial production has been expanding at an anemic 1.0% annual rate, and employment growth—at about 1.1% year over year—remains well below average. Economic conditions are, on balance, not robust, raising the likelihood of downward revisions to corporate profits should weakness persist. At present, there are no credible policy initiatives that would meaningfully improve economic performance.

History occasionally reminds investors of the inherently uncertain nature of stock-market returns. The widely held belief that equity returns follow a well-behaved pattern is challenged whenever outcomes fall outside the range considered reasonable based on past experience. The October 19, 1987 market decline—more than 20% in a single day—remains a notable example. Today’s market valuations suggest that investors are assigning a low probability to the possibility of a substantial decline.

Frank Knight’s Risk, Uncertainty, and Profit, published in 1921, remains highly relevant in this environment. Knight argued that genuine uncertainty—not quantifiable risk—is the true source of profits in excess of the average return available to all market participants. Risk can be measured and avoided; uncertainty cannot.

Conditions are now in place for a period in which uncertainty becomes increasingly evident. For those who rely exclusively on data to guide expectations, such conditions will offer little comfort. Discomfort will follow.