Narrative sentiment and attention matters - Read the news!

 

In the paper "The Power of Narrative Attention: Linking Geopolitical and Economic Storylines to Currency Risk and Return Predictability", the authors find that narrative shocks are not fully priced into FX markets and will impact returns over a period of weeks. Even after accounting for major factors, fluctuations in currency markets show time-varying exposure to economic narratives such as recessions, trade wars, and inflation. Narrative sentiment can vary depending on the tone and volume of coverage.

Even if you are a quant, you should read the news and stay aware of current market narratives. However, these narratives can be systematically measured and incorporated into a model to increase explanatory power. We always knew this was the case, but the key finding is that narrative sentiment persists and is independent of other factors.

Be situationally aware of what is being reported in the news, which can often be systematized. 

Global equity correlations falling - flows following cheapness

The overall tendency for correlation across global equity indices is high, given strong economic integration across countries and the multinational business of large-cap stocks. Nevertheless, we note the current decline in equity correlations. The US is obviously moving higher on tech (Mag 7) and strong valuations. We note that the Mag 7 is showing increased dispersion, and valuations outside of tech are more reasonable; however, perceptions and flows suggest a decoupling as investors look for cheaper investment opportunities. The theme of seeking international cheap valuations will drive investor focus in 2026.

Equity markets overvalued, but what should you do?

 

The talk of overvaluation always has to be placed in context. It has to be given a number. High P/E levels are associated with lower future returns. This is a strong headwind. Does this mean that stocks will fall soon? That is less clear. The equity risk premium is falling, but it is still wider than it was during the tech bubble. There is also evidence that forward returns will be higher than what is predicted by valuations. 

Our concern is the catalyst that will cause a decline. High valuations coupled with macro shocks are the combination that will send stocks lower. The real macro economy is not as healthy as many think. Consumer sentiment is lower. Survey diffusion data is at best neutral but tends to suggest a slower economy. Shipping is down. While the Fed may not lower rates because of inflation worries, there should be growing concern about economic growth.

Commodities diversification more than just gold

The talk of the commodities markets has been gold and silver, yet this asset class is much larger and still offers investors diversification opportunities. Diversification is more than just correlation - it requires respect for returns. However, investors should not forget that many commodities and sub-commodity groups can provide diversification for the same reasons as gold. Real assets are effective hedges when inflation is still above central bank targets. There will be cycles, but at high gold price levels, other real assets become more attractive.