How stories drive the financial markets and why markets are currently declining.
In this podcast, you’ll learn:
- What are money manager beauty pageants.
- How financial markets are driven by stories.
- Why we shouldn’t invest based on stories.
- Why it’s important to understand market conditions.
- What are today’s conditions in terms of market valuations, the economy, sentiment and momentum.
- What is earnings yield.
- What is the level of conviction buy-and-hold investors need to display during market sell-offs.
Is The Story Changing?
I used to run beauty contests for investment managers.
They weren’t really beauty pageants, but that was our pet name for what is known in the institutional investing world as a finals presentation.
In a finals presentation, we’d invite three or four investment managers to present for thirty minutes to a client of ours, such as a college foundation investment committee.
The client usually had never previously met these firms in person, although we provided them plenty of information about the investment managers beforehand.
After the firms finished their presentations, the committee members would discuss the candidates and select one of the firms to manage a $10 million or more chunk of the client’s investment portfolio.
Why They Won
I found these contests fascinating. Each firm was equally qualified as our research team had already spent many hours conducting due diligence on their respective investment processes, philosophy and performance.
That meant the winner of the contest was often decided by something other than investment factors.
The decision usually came down to storytelling, poise, confidence and at times looks. Hence, a beauty contest.
This was a perfect laboratory to observe the dynamics of group decision making.
Of course, the investment committee members would never say they were recommending a firm be hired because the presenter was a better storyteller, but having sat through dozens of these meetings over the years that certainly seemed to be the case.
The stories these managers told usually followed a similar narrative arc.
The managers described how through extensive due diligence efforts they were able to connect the dots and develop an investment thesis for what they thought was going to happen in the future for a particular company, security or market.
Of course, what they thought would happen actually happened, bringing their clients significant wealth. The managers would then emphasize how this investment process was deeply ingrained in their firm’s culture and was thus repeatable.
Not only do we enjoy the stories of others, but we are storytellers ourselves. It is how we deal with uncertainty.
Daniel Kahneman in his book Thinking, Fast and Slow writes
“You cannot help dealing with the limited information you have as if it were all there is to know. You build the best possible story from the information available to you, and if it is a good story, you believe it.”
“Paradoxically, it is easier to construct a coherent story when you know little, where there are fewer pieces to fit into the puzzle. Our comforting conviction that the world makes sense rests on a secure foundation: our almost unlimited ability to ignore our ignorance.”
Nowhere is complexity greater, ignorance more abundant, and storytelling more cherished than in the financial and investing world.
The financial media, strategists and gurus are paid handsomely to tell us plausible stories about what is happening and why and what will happen next.
We use those stories as well as those our own making to both guide and rationalize our personal investing and financial decisions.
With so many stories being told, invariably there are some that become more popular than others. These are the leading narratives that drive the direction of financial markets.
Financial market volatility is usually a sign the lead story is changing.
For example, since 2011, a lead story has been the stock market would continue to climb because the global economy was expanding but only modestly so central bankers would do whatever it took to ensure the recovery continued.
This story was so entrenched that when financial markets occasionally swooned, the clarion call of many investors was to “buy the dip” by investing more money in the stock market.
Now with oil prices down 20% since July, Europe on the brink of a recession, and interest rates and stock markets falling across the globe, investors appear to be searching for a new lead story as the old one has lost some credibility.
This story finding is both a fascinating and terrifying process because the reality is no one has a clue what is going to happen next—how the story will end.
Still, a lead story will eventually emerge and markets will calm as investors coalesce around a new leading narrative.
A critical question is at what level will stock indices and interest rates need to reside in order to reinforce a new lead story.