The stock market tends to trade based on narratives. Narratives are stories that try to make sense of the various data. The financial media as well as analysts that work for the big Wall Street firms put forward the narratives. The narratives can be self-serving to those that put them forward: they may provide a slick theory as to why things didn’t go as they previously thought, or they try to persuade current and potential customers that their view of the world is more appropriate than other views of the world.
This notion of narratives is important to you because rather than trading on fundamentals such as earnings, sales, growth, etc., the market trades on these narratives. The job of an investor (as well as of an investment manager) is to sort through the narrative and determine which are valid and which are bogus. Sorting through narratives requires nuance. It’s as if you are watching to see what others do with the narrative and react accordingly, rather than judge something as undervalued or overvalued based on intrinsic factors and buy or sell accordingly.
It seems there is often one story, one narrative, that dominates all of the talk related to the stock market. Sometimes more than one, and they can be linked, but usually there is one dominant narrative. During this turbulent period we have faced in February 2018, the narrative is that inflation is back and interest rates are on the rise. The premium we pay for stocks (over bonds) will decrease, and corporate earnings will suffer. All because a 100 basis point or so rise in future interest rates. Will this be proven correct? Nobody knows, but stock investors are preparing for the worst, after having lived through an easier investment climate for the past year plus. It’s difficult when your assumptions change.
What about you? Do you believe this is an over-hyped narrative, or do you think it is totally valid? Or do you think it is hard to tell? I am probably in the “hard-to-tell” camp, leaning toward over-hyped.
Past narratives include:
- Oil prices are falling and this will be good for the economy because it will reduce energy costs for US industry as well as at the gas pump. This was in late 2015, as oil hit $60/barrell and started to trend downward.
- Oil prices are falling and this will be bad for the economy because the US is now one of the largest oil producers in the world and a good deal of our job growth has been in the oil drilling sector. This was in early 2016, as oil ultimately got below $30/barrell.
- Greece is going bankrupt and this could also mean the end for the European Union and therefore disrupt the world’s economy. Remember when Greece seemed like the only economic news being reported? This was about 3 years ago.
- 2008: The subprime mortgage market is showing an increasing default rate, which is causing problems in the housing industry, and ultimately in the entire banking industry. This narrative, it turned out, had legs, probably because we were seeing just the tip of the iceberg early on and the vastness of the problem and the intertwining of the various banks became revealed as time went on.
There are many, many others. The narrative changes sometimes every day, as the media tries to sum up each day’s market action with a quippy soundbite that tries to get it right.
I believe narratives serve a purpose, but as investors, you need to recognize the narrative and its purpose and decide for yourself how valid it is. Sometimes, the narrative becomes more overwhelming than it should be. Alternatively, if you don’t have time to keep up with the news yourself, if you are too busy with your own job and family, you can delegate that job to an able, experienced investment manager and live with their decisions. Please contact me if you are so inclined.