After a string of up days, most markets were showing red earlier today. We never know what the daily action of the markets will look like in advance. Whether you want to call it a random walk or the madness of crowds, those of us who toil in the capital markets can rely on no two days being the same.

However, one thing that occurs regardless of circumstances, data or specific events: The endless attempts made to explain the day-to-day in a narrative format. This futile gesture seems to occur regardless of the overall circumstances. Investors want an explanation that gives them comfort, even if their portfolio fails to do so.

Hence, our love affair with the “if-that” news dynamic. IF this occurred, then THAT was the natural reaction in the markets. One of the few guarantees that can be made in investing is that you will be subject to an endless stream of this sort of explanation.

What were this morning’s excuses for why markets were soft today? Pick your poison:

• U.S. retail sales “unexpectedly” fell 0.4 percent because of inclement weather in January;

• Weak earnings from companies as varied as BNP Paribas to Cisco Systems undercut the expansion story;

• Some currency issue somewhere — today it was the Swiss franc that was rallying! — therefore something else is doing poorly;

• Europe’s six-day winning streak was due to end eventually.

We can debate the merits of any of the above data points, but the simple reality is that there is only so much valuable information to be derived from observing the news flow. When we consider the day-to-day action of markets, we see it is mostly random noise, very little of which makes much difference over the long haul.

Indeed, the longer your timeline, the more even significant events look like just little squiggles. Consider such world-shaking events as the JFK assassination, the 1987 stock-market crash, or the 9/11 terrorist attacks. On a long-term chart of the Standard & Poor’s 500 Index, they are reduced to static. Over the long haul of history, even monthly action starts to look like not very meaningful noise.

Why is that? I place some of the blame on that very if-that format, which came about as a function of our love of narratives. The narrative is the preferred way to share information across just about every human culture.

Sure, it is very often misleading, but it works for most typical forms of information transfer. It is incumbent upon us to recognize how often this format creates context or analogs that are simply false. Credit the field of behavioral finance for identifying just how misleading — and costly — the narrative format can be.

I want to address this issue in much greater detail in the near future, but suffice it to say that the desire for an easy to follow and memorable narrative typically trumps accuracy and precision almost every time.

Why were the future down this morning, and why has the market recovered since then? To answer that, I have to tell you a story.


Originally: Stock Market Stories Lead Us Astray

Category: Markets, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

9 Responses to “Narrative Rules”

  1. VennData says:

    The slippery slope argument gets you to try to to explain an hour, or a minute of market action.

    Or a year. How can you explain a 30% rise in the S&P in 2013 on top of 9% earnings growth?

    They simply can’t.

    • Bob K. says:

      Sure you can. look at the Fed’s balance sheet and growth projections. Taper is now in motion for now, and so step down 10 x of market value of the loss of banks excess reserves on each announcement and reproject the slope of purchases out six months. Place a standard deviation channel around the slope and trade away. Rinse and repeat.

      This is a math function based on the Federal Reserve. Anyone paying anyone to manage their money based on any other fundamental analysis is an idiot.

  2. Concerned Neighbour says:

    After the best week in 13 months, the “markets” steadily decline overnight only to shoot up near instantaneously on worse than expected economic news. There is no narrative there? I would strongly disagree. The narrative is clear: the powers that be seem hell-bent on never letting these “free markets” fall ever again. The concept of a “free market” is a lie people tell their children.

    Ordinarily I would agree that it’s a fools game to read too much into day to day movements, but things change when the “markets” are essentially controlled by one class of participant. We are rapidly approaching a time when it will be impossible to find a “blue chip” trading for less than 20 P/E in a moderate growth environment. Those running this farce clearly aren’t value investors.

  3. farmera1 says:

    It always amuses me to see the financial “experts” trying to explain random day to day variations in the market, when by definition there can be no known causes. Doesn’t slow the experts down one bit, just put a bunch of BS out there and people take it seriously.

  4. Iamthe50percent says:

    I knew these narratives were bogus when I heard the very same explanation for one day’s fall being used for the next day’s rise.

  5. TDHawk says:

    “I want to address this issue in much greater detail in the near future, but suffice it to say that the desire for an easy to follow and memorable narrative typically trumps accuracy and precision almost every time.”

    I’d like to see this alternative that you keep mysteriously mentioning. You’ve been explaining the inability to predict the future in your articles. Now, I’d like to see further discussions on the George Soros way of looking at multiple possible events view.

    What is this specific term for this kind of contrarian and systematic analytical process?

  6. MEMBER 7291 says:

    I wonder why all these angry commenters on Bloomberg, FT, etc. who claim the markets are rigged by the powers that be to never fall again don’t just sell puts and buy stocks. If stocks can truly never go down again, you should at least make some money off of it.

    • Concerned Neighbour says:

      MEMBER 7291, there is a difference between investment and speculation. Investment is based on quaint concepts like earnings, cash flow, dividends, tangible book value, and so on. Rampant speculation, which is what the Fed has inspired, is based on momentum, good or bad news, and easy money. As shocking as it may seem, there remain a few old-fashioned investors who will not commit a significant portion of their portfolio in the expectation of the system’s continued and ever-increasingly blatant corruption.

      I do happen to believe these “markets” are unlikely to ever go down significantly again, for they really aren’t “free markets” anymore. The central banks have far to much invested in maintaining this farce to ever give an inch. That doesn’t mean I’m going to buy blue chips at 25 P/E hand over fist or “growth” stocks at 700 times sales, etc. More power to you if you think different.

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