Everybody loves a good story
Barry Ritholtz
Washington Post, July 26 2013



When it comes to storytelling, we have a long and venerable history of narrative. The spoken word emerged millennia ago — before even the Greeks — when the only way to share knowledge was verbally, person to person, generation to generation.

It is in your DNA to love a good story. You know, neat tales with heroes and villains and conflicts to resolve. A good story pushes our buttons, is exciting and memorable.

It should come as no surprise that Wall Street also loves a good story. And when Wall Street spins a yarn, its emotional pitch drives sales.

In the parlance of the Wall Street brokers, these are called “story stocks.” You have heard them: A new CEO is bound to turn the company around. The FDA was about to give Phase 3 approval to a miracle drug with a billion-dollar market. A sexy new product launch was going to catapult the stock price. And everyone’s favorite fish tale: the imminent takeover play.

Of course, many of these stories turn out to be wrong. Surprisingly, that is not what gets us into trouble as investors. As it turns out, it doesn’t matter whether a story is true or false. It may be counterintuitive, but even true stories can end up being money-losers.

What matters most to you as an investor is the entire concept of the narrative. You have a natural tendency to want an emotionally satisfying tale — and to make investments based on that — despite times when the actual data may be telling you something different.

Consider a few examples of these stories. I recall in the early 2000s the “Apple is going out of business and what the heck is an iPod anyway?” story. (AAPL shares were $7.50 at the time). The updated version was how cheap Apple was at $700 given its low P/E ratio (or price-earnings, how the company’s share price compares to its per-share earnings). In this case, the data suggested looking instead at the slowing growth rate.

Or consider the gold narrative — it was going to hit $5,000 because of the Fed’s quantitative easing program. Well, the Fed is still doing QE but gold has fallen as much as 30 percent from its highs. Guess they need a new narrative. (Maybe this one will have more staying power.)

How many people have been calling for a market crash now for several quarters if not years? Cullen Roche of Pragmatic Capital describes what may be the biggest narrative failure: the Fear Trade.

“If you’ve been paying attention over the last few years, you probably remember how many people predicted hyperinflation, surging bond yields, soaring gold prices, a cratering U.S. dollar and a collapsing stock market. This was the fear trade. You overweight gold, short U.S. government bonds, short the USD, short equities and laugh all the way to the bank. On the whole, that trade has been a big disaster. In other words, fear lost out — again.”

He is right: None of those things has come to pass. Even worse, the fear traders have missed a 150 percent rally to all-time highs in the U.S. stock markets. While sell-offs are painful, over the long haul they tend to be temporary. The mathematics of asset class mean reversion is inescapable. Stocks will eventually recover, but if you fail to participate in a generational rally of this magnitude, it can set back your retirement by as much as seven years.

Perhaps there is a deeper reason for all the angst. We have witnessed the same sort of narrative failure in other fields as well. It is rife in economics, where the austerity narrative has all but collapsed. In politics, the supposed class battle between makers and takers never materialized. Even in climate change, a number of skeptics eventually gave up on their arguments as the data overwhelmed the conspiracy narrative.

As John Kenneth Galbraith famously said, “Faced with the choice between changing one’s mind and proving that there is no need to do so, almost everyone gets busy on the proof.” Rather than accepting certain unpleasant realities, many participants have contorted themselves into a painful waiting game. They are “busy on the proof.”

This is why I do my annual mea culpas. The simple reality of life is that everyone is wrong on a regular basis. By confronting these inevitable errors, you allow yourself to make corrections before it is too late. Traders are fond of the aphorism “It’s okay to be wrong, but it’s unacceptable to stay wrong.”

And expensive as well. I am fond of pointing out that cognitive dissonance is a very costly hobby. As many of the above mentioned narratives have failed, few are willing to admit error and face the music. Instead, they double down and make further bets. “I am not wrong, just a little early!” is the hopeful mantra of these cognitive dissidents. The Dow will sink to 5,000 eventually. The dollar will eventually collapse (along with the rest of the “fiat currencies.”) Hyperinflation is around the corner. Gold is gonna hit $10,000. Don’t blame me when the Great Recession II comes!

It’s not that any of these things is specifically wrong — they are all possible outcomes — but rather, the problem is the reliance on narratives that are by design money-losing stories, torturing the data or ignoring it entirely.

It’s clear when emotional storytelling gets in the way of intelligent investing. We can see strategists come up short in their forecasts, and then offer a series of excuses for why. We all have witnessed the investor rationalizing why he was right and the markets were all wrong. How many traders have you seen doubling down on a losing trade, despite the obvious failure of the original thesis, rather than admit the error?

All of this is based on sticking to a story no matter which facts present themselves. “Who you gonna believe — me or your lyin’ eyes?”

I call this the triumph of the narrative over data, ideology over intelligence, politics over facts, emotion over planning.

Here is my favorite astonishing (but by no means surprising) data point: As of the middle of 2012, in self-directed 401(k) plans, “The biggest single equity holding was Apple . . . followed by the SPDR Gold Trust,” according to U.S. News.

That’s what you get by investing by a well told if erroneous and unsupported story.

What narrative are you following?




Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. Follow him on Twitter @Ritholtz.

Category: Apprenticed Investor, Psychology

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9 Responses to “Curse of the Narrative: Everybody Loves A Good Story”

  1. JasRas says:

    The narrative that a stock market can do very well in a “meh” economy and a gridlocked D.C…

    The narrative that we are entering a rare period where we can benefit from the aging Babyboomers on the backend or their cycle AND the Echoboomers as they get started on their journey. We’ve only benefitted from one so far in my career…

    The narrative that excess capital flows to where it works the best, and when one looks around, that is equities. People are too unsure to invest long term in people, capital equipment, expansion, but they know they can gain access to their $$ in T-3 or less in the market. An uncertain environment in the economy benefits equities.

    The narrative that while the bond market likely won’t spin outa control, each “stair step” up in yield will mean a further permanent loss of capital not likely made up by the cash flows paid by the bonds(funds, etfs) held… so it is better to accept the “risk” of increased volatility in equity than the reality of permanent principal loss.

    The narrative that the economy is not hot like a grill or stove top, but more like a Crockpot. It ain’t fast, but it is cooking–veeerrrry slowly.

    The narrative that we always complain and pine for what was, but those who play by what is and adjust have the chance to excel first and best. I can’t say “quality” jobs will every return, but jobs are returning and it moves the dial, for instance. Accepting who and where you are now and how the rules are now behooves any investment strategy. I can take the long view that Europe is screwed or that demographics total mess up Japan, but the level of certainty is low. The short view is a GDP in Europe over zero will be much better than anytime in the last 2 yrs and ABEnomics is working in Japan. Take advantage.

  2. jaymaster says:

    One correction:Cullen Roche’s blog is Pragmatic Capitalism, not Capital.

  3. faulkner says:

    Well said Barry. Narrative are how we humans originally made and exchanged knowledge, and also explained mysteries, justified traditions and authorities, imagined possibilities, made excuses, and entertained ourselves … and still do. No wonder it’s so pervasive and persuasive and mixed-up.

    Modern narrative research finds that most stories are created and told post-hoc and have little predictive value. Their ‘purpose’ appears to be to bind events together to make meaningful and hence memorable experiences as well as maintain a positive sense of self/egotism.

    So what is an investor to do? First, realize you cannot not tell stories. You closing question is a wonderful way for investors to remind themselves of that, and begin to develop perspective.

    Next, while most investor stories are about the markets and the future, the most important story is the one you tell about yourself – what kind of investor you are. I have admired your willingness to say you are “wrong on a regular basis.” That story element is quite different from most market participants. It gives you considerable flexibility and a distinct advantage over those whose stories include how brilliant, insightful or prescient they are. (A major use of stories is to generate excuses after the fact.)

  4. RW says:

    One of the most destructive narratives the past five years has been the intellectually bankrupt policy of govt austerity during times of economic contraction and high unemployment. One of those arguments currently in vogue among VSP is that unemployment is ‘structural’ (meaning intervention would be pointless so let’s do nothing).

    A very recent case in point:

    Structural Humbug

    In short, the data strongly point toward a cyclical, not a structural story — and there is broad agreement, for once, among economists on this point. Yet somehow, it’s clear, Beltway groupthink has arrived at the opposite conclusion — so much so that the actual economic consensus on this issue wasn’t even represented on the Newshour.

  5. [...] Curse of the Narrative: Everybody Loves A Good Story [...]

  6. catman says:

    For those of us with liberal arts degrees and basic math skills the narrative is very important. The issue as I see it is twofold. The good news is being able to parse the narrative, read between the lines and discern the all important psychological state of the market. The problem is getting caught up and over anticipating future results. Wishful thinking is not a viable strategy.

  7. Frilton Miedman says:

    My narrative is mechanical, observing cyclical mean reversion based on sectors I understand tangibly with a little help from people/pundits I trust.

    Observance of long term business/inventory cycles and underlying conditions that influence it (easier said than done, with TBTF futures manipulation and special interest’s influence over back room legislation) and an ear to the ground on the Fed & knuckleheads in D.C., I strategically short froth with caution – been short treasuries for over a year, I’ll take the gain as rates resurge to historic norms while (if) D.C. gets it’s head out of it’s ass and stops putting the Fed in that position,

    2% on the 10/yr, has been the bottom for at least a century, and these moves tend to happen over decades….also mindful of which sectors are more sensitive to credit conditions.

    Regardless of “mo-mo”, “go-go”, and purported economic devastation because corporations & the 1% might pay taxes and “gold is going to $5,000″,, or whatever the flavor of the day is. the cycles always revert, it’s the premise behind Dow theory and Dogs of Dow.

    I listen to Fast money as advice for which stocks to avoid, I have a small list of pundits I listen to for idea’s on where to look, not what to buy. Ritholtz is one of them.

    In relation to Plato’s allegory, only a fool thinks he’s above viewing the proverbial shadows, we all do, the idea being to know which shadows to watch, which to ignore.

  8. Angryman1 says:

    To extent RW, I agree. Though the US didn’t to 2012 start engaging in “austerity”. The economy has held on so far and the private sector is more optimistic than ever. That is a big reason behind the upward move(recovery) in the markets as the ‘pros’ are optimistic and boosting valuations to spur investers to spend more(which will lift long term rates over time as well, increasing financial loans).

    In the post-war era, the government would issue high tax rates and push for a more internally driven investment patterns to boost nominal income and that was ok for markets to the run on gold by the late 60′s. This crunched supply and inflation started getting out of control with the demand surge from the Boomers.

    Now with low tax rates and little government interference for income growth, there is not much to invest in outside equity markets. So that is where they go to ‘stimulate’ the economy, which also explains the ‘strength’ of the 80/90′s bull run and the cyclical surges in the secular bear. It also has had a tendency to completely cut off capital from the production side.

    IMO, if the government turned cheek and started pushing income driving policies, the stock market would be as dead as it was in the 70′s and inflation would rise(probably out of control).

  9. [...] Curse of the Narrative: Everybody Loves A Good Story (August 3rd, 2013) [...]