Friday, November 6, 2020

The failure of ungrounded investment narratives

The polls got the US election wrong. Financial analysts also got their narratives wrong based on those polls. Remember the “blue wave” story of investment success this fall based on increased fiscal spending coming in 2021? That story has now turned to the “gridlock is good” narrative to explain current equity performance. It will likely switch  again as narratives try to explain that which is not understood about current market behavior. Narratives are used to fill the void of what is unknown in order to provide a sense of safety and control. A good story can provide comfort. However, it can lead to predictive failure if it is not grounded in a theory or in empirical evidence.

Is there a basis for the “blue wave” or the “gridlock is good” narrative? At best, there are just some past events that can be used as an initial point for extrapolation. The presidential polls providing a basis for equity prediction was a story without theory. There is a political cycle but that theory was not linked to the blue wave story.

There will be no blue wave. There may be gridlock, but this just means that it is less clear what will be the policies of any administration. It is not a theory linked to investment performance except as repudiation of a blue wave. Two stories completely at odds with each other but leading to the same outcome. 

Narrative is a powerful tool but used inappropriately it can harm an investor audience.

  • Narratives can be used to explain but are not always stories that can predict.
  • Narratives do not always add to our understanding but can subtract from reality.

The alternative is not to fit price behavior to a story, but just follow the prices without any explanation. Prices trend up which means buyers are clearing the market at a higher price. There is no story forced on the market. The accumulated behavior from market participants changes prices and that may be the only signal necessary in an uncertain world. Some investors may add more to the trend story, but without clear information, the unadulterated trend is still a good base position for any forecast.

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