“He can take a model and turn it into a narrative”


Right after the election, Felix wrote a post “When quants tell stories.” Clever as it was, I had issues with the underlying premise – namely, that the value of Nate Silver’s modeling lay more in the narrative tale as told by Silver himself and not the underlying  mathematics of statistical probability analysis.

As I read this, I kept thinking “Not exactly.”

I have been meaning to address this for some time, but a hurricane and a few weeks of no electricity got in the way. Before this gets away from me, I wanted to look back to see where I concur with Felix’ assessment, and where we disagree. It is an interesting story and an important idea – but there are a few specific points that are worth discussing.

Let’s start with the money quote:

“If you think that the value of Nate Silver is in the model, you’re missing the most important part: there are lots of people with models, and most of those models are pretty similar to each other. The thing which sets Silver apart from the rest is that he can write: he can take a model and turn it into a narrative, walking his readers through to his conclusions.”

That’s the paragraph that bothered me the most. We both agree that Nate can write – he is an effective communicator, informing his readers about a moderately complex statistical model in a way that is both informative and entertaining.

Its the rest of that paragraph that I had an issue with:

-Lots of people had models, which ranged from okay to terrible
-Most of the models differed significantly from each other
-Lots of people told interesting stories, but they got the narrative and the conclusions wrong
-A few people had models that got it right; some were good, others lucky.

Despite those errors, what caught my interest as an investor was the discussion about Narratives. It is in exactly this context that I want to discuss what a “Narrative” is conceptually, and what it means to those who toil in the Capital Markets.

It is more than just a story, rather it was a way to look at and describe the world:

-Narratives are about selling a perspective
-Narratives typically focus on squishier, less quantifiable aspects of an issue
-Narratives often hit emotional buttons, making the reader feel good about the story.
-Narratives are about the outcome, not the process.
-Models are about process;
-Good models produce a consistent process, which is more important than any single result.

In the world of investing, the Narrative is how a given stock or investment thesis gets sold. Narratives are how the threads of the story weave a tapestry that leads to an action: Buy this stock, sell this mutual fund, vote for this candidate.

Whenever a broker is pitching a stock to someone, there will invariably be a statement along the lines of “What’s the story with this stock?”

The answer usually involves a narrative that discusses some combination of the following:

-Management Team
-New Products
-Growth over competitors
-Strategic Acquisitions
-Penetrating new markets
-Value proposition
-Earnings Story
-Expansion overseas (China!)
-M&A target

Taken collectively, the stock narrative makes for a compelling story. Where it falls apart is when any of these items are closely scrutinized — the past track record of these inputs is found wanting.

Ask yourself: Who has the acumen to look at a management team and draw a conclusion about future stock growth? Almost nobody (in my experience). What is the narrator’s track record doing stock picking based on just that (or anyone elses for that matter)? The Narrator’s assessment of new products, markets, takeovers, etc. — how good has it been? These hot button issues simply fall apart as a method of selecting stocks that will outperform over either the short or long term.

However, there is an enormous difference between being able to communicate what the mathematics is informing you of, and living and dying by a narrative (often sans data). Consider Peggy Noonan — a compelling wordsmith, best selling author, and former speechwriter for Ronald Reagan. She and other non modeling story tellers constructed terrific narratives about a variety of emotional issues, none of which statistically mattered.

My favorite example was the yard signs in Florida reflecting an advantage for Romney in enthusiasm amongst his political base. There are very obvious modeling issues with that: What was the method for measuring those signs? How widespread was this nationally, and more importantly, in swing states? What is the past correlation between numerical signage advantages and election outcomes, etc?

Looked at that way, the narrative approach which only feigned a measure of statistical accuracy utterly failed. The tellers of these tales helped make themselves feel better emotionally, but these narrations did nothing for their forecasting acumen.

And that is the primary problems with Narratives: They exist to make us feel better — about a stock purchase, an election or even ourselves.

Humans are fond of using narratives to describe the world around them. Perhaps it is a vestige left over from when we had no written language. Narratives were how we passed along crucial information in a memorable way. The depiction of facts and figures simply was not a compelling form of communication to hunter gatherers.

Investors need to remember this whenever they are told a story. Narrative may be entertaining, but they won’t make you money.


Lessons from the 2012 election (Washington Post, November 10 2012)

Nate Silver and the Lessons of 2012 (November 6, 2012)

When quants tell stories
Felix Salmon
Reuters November 7, 2012

Category: Investing, Mathematics, Philosophy, Politics, Quantitative, Really, really bad calls