Created: Jun 19, 2021 8:00 AM
Filmmakers use the phrase “storytelling is everything” to emphasize the importance of storytelling to their profession. They understand how a good script communicates to the viewer, attracts them and makes them take root for the protagonist. Without a good narrative, even the best actors inhabiting the most wonderful characters are in danger of not entertaining. Great stories can terrify you, warm your heart, or grab your attention.
Follow the story: Short-term market movements tend to be driven by storytelling
It seems the stories have everything to do with the markets these days, which also creates new risks for investors. The biggest and most controversial debates revolve around stories rather than fundamentals, ranging from the usefulness of cryptocurrencies to whether the current spike in inflation is transitory, and the question of if dizzying assessments are warranted or if there is too much fiscal and monetary stimulus.
This is in stark contrast to how beliefs about investing evolved – beliefs based on math and cold, hard logic. The “narrative paradigm” can be attributed to a theory of communication conceptualized by the late Walter Fisher, professor emeritus at the USC Annenberg School for Communication and Journalism. Fisher observed that meaningful communication occurs through storytelling because “stories are more persuasive than logical arguments.”
Consider the following examples of stories driving, well, just about anything in the markets today:
Bitcoin: fiat currency has been degraded by government bailouts, largesse from central banks and other misguided interventions! It is possible that this recklessness will lead to a massive switch to digital currency. Buy bitcoin and drive Lamborghinis or stick with fiat currency and own worthless paper.
Shortage of workers: generous unemployment benefits prevent lazy and ungrateful rascals from returning to work! Counter-speech: many schools still operate remotely and daycare centers are difficult to find. Moreover, a large number of new business start-ups and a record number of people leaving their jobs show that workers are not lazy, simply avoiding inflexible and low-paying jobs.
Passive indexation: iIt is difficult to choose winning stocks! Not only that, it’s expensive to hire people who might be able to pick the winning stocks (and you won’t know who they are until it’s too late). Why not buy a cheap index of the biggest stocks or the entire market instead?
Inflation: combine ultra-low interest rates and strong stimulus with pent-up demand as vaccines lead more of the economy to open. This story is the perfect formula for higher prices and higher inflation expectations!
Evaluation: buying stocks below their intrinsic value is a good way to make money over the long term. Counter-narrative: Traditional measures of value need to be more robust than price-to-sell or price-to-earnings ratios; it should include the growth rate and intangible assets such as patents, algorithms and business processes.
Memes stocks: the collective power of the internet can stick it to man! Wall Street bets can identify stocks that are heavily short and, as a group, buy calls out of the money, forcing a massive short-squeeze. Power to the people!
The idea of memes stocks as a narrative led me to contact Yale University professor and Nobel Laureate Robert Shiller to ask if “everything is narrative” is an exaggeration. He is also the author of Narrative economy: how stories go viral and lead to major economic events. “In an email exchange, he pointed out that the account is only half of it:
“A story is becoming new on everyone’s lips not because it’s true, but because its rate of contagion has increased or its rate of recovery has decreased, just as viruses can see a surprising new spread due to a subtle mutation. The stories’ contagion rates are affected by factors such as superficial resemblance to recent events, celebrity relationships, and even sometimes their outrageous and daring lies. “
Therefore, the inherent power of storytelling is only part of the picture. Much of the influence of the narrative comes from the virality of a plot. A good story can convince you, but a good one can go viral. Bitcoin becoming a trillion dollar asset not only because of the strength of the story behind it – the myth of Satoshi’s genesis, the technological applications of blockchain, the inherent scarcity of mined coins and interventions. post-financial crisis of governments around the world – but how this narrative resonates with so many different factions of investors.
But these “narrative illusions” present an obvious risk for investors. When we believe in a compelling story that turns out to be wrong, we may end up owning assets that are much lower in value than the story suggests. This is especially true in the daily market price action, which can be “loud and irrational”.
Shiller adds that stock prices are greatly influenced by narratives, but over time they will come back to reality: “I said that the theory of efficient markets is. [at least] half true. Therefore, viral narratives may be the initial drivers of higher valuations, but these companies must ultimately generate revenue and profit growth.
To update what Benjamin Graham, the father of value investing, once said: “In the short term the market is a narrative machine, but in the long term it is a narrative demystifying machine.