“News is not important. It is the way the market reacts to the news that is important.” – Joseph E. Granville
According to economist Robert Shiller, the narratives constructed by the media are a powerful force that can sway people, industries and even whole countries, “[The] human brain has always been highly tuned towards narratives, whether factual or not…Stories motivate and connect activities to deeply felt values and needs. Narratives “go viral” and spread far, even worldwide, with economic impact.”
Shiller goes onto describe how narratives affect asset prices, which in turn affect economic activity and then back to the narrative in a positive feedback loop:
“In a bubble, the contagion is altered by the public attention to price increases: rapid price increases boost the contagion rate of popular stories justifying that increase, heightening demand and more price increases. In a stock market bubble, these might be stories of the companies with glamorous new technology and of the people who created the technology. In a housing bubble, these might be stories of clever people making a fortune flipping houses. There can also be price-to-GDP-to-price feedback, if speculative price increases stimulate purchases and hence more increases, price-to-corporate profits-to-price feedback, and price-to-regulatory laxity-to-price feedback, all mediated by changing narratives.”
Up until recently economists have dismissed the power of narratives to move economies and markets, taking the attitude that if it can’t be measured then it doesn’t exist. Unfortunately, data doesn’t tell the whole story. The narratives we are told about the economy and markets have the power to perpetuate booms, but also lead to busts.
What were the narratives leading up to the Great Recession of 2007-09? In 2001, the UK television show “Property Ladder” was launched. It depicted individuals buying homes, doing them up a little and then reselling them at a large profit. The concept was copied by other countries, e.g. the US TV show “Flip that House”. These TV shows, as well as magazines and other media fed the narrative that you too could become a property millionaire with very little effort.
Economic and financial narratives can be very sticky, often lasting decades if they are enshrined in an important financial institution’s identity. Institutional memory is typically thought of as its collective knowledge of facts, experiences and concepts. Sometimes institutional memory becomes enshrined in its identity, perhaps even as an ideology.
One long term narrative from economic history is that of Germany’s central bank, the Bundesbank. It had a stored set of memories directly linked to the traumatic economic experience of the hyper-inflationary Weimar Republic. Investors believed that the Bundesbank would continue with its hawkish inflation narrative even though several decades had past.
Another strong narrative that has developed over the past couple decades is the omnipotence of central bankers. Traced back to the early 2000’s investors coined the terms ‘The Greenspan Put’ and ‘Don’t fight the Fed’, referring to the actions of Federal Reserve chairman Alan Greenspan to support the stock-market.
This belief in the narrative of superstar central bankers became endemic after the Great Financial Crisis. Central banks unleashed quantitative easing backed up by forward guidance, in effect telling investors what to think about the economy. For example, European Central Bank (ECB) president Mario Draghi’s “Whatever it takes” speech. Remember, institutionalised narratives can last much longer than we ever think possible!
Headlines reflect the consensus narrative
Digesting the financial news headlines at the wrong time of day can be bad for your personal and financial health. That being said, headlines can, when you are able to think about them rationally, offer important clues into the state of financial market narratives, potentially opening up opportunities for investors.
According to Peter Atwater, President at Financial Insyghts, “The morning headlines in the Wall Street Journal, the Financial Times the New York Times, the Washington Post…are huge mirrors. They are telling us how we feel and what we believe to be true.”
The front page of a newspaper, or the opening items on the TV news broadcast confirm what we already believe to be true. After all, the media are trying to move us onto page 2 and so on, and to stick around for the next item on the TV news bulletin.
You’ll meet a bad fate if you extrapolate
According to Atwater trends which are “over-believed” by investors, those are easily extrapolated into the future are the most dangerous for investors, “When everyone believes something is going higher, like interest rates last fall, the opposite is likely. As I write often, extrapolation kills. And the bigger the trend-extrapolating headline and the more prominent the headline’s position, the more likely a reversal is. Typically, when something makes it to front page coverage, the end is near.”
Magazine front covers also have a long history of proclaiming erroneous predictions at critical turning points in both economic activity and the markets. Far from being prescient, instead they tend to extrapolate current trends. Two of the most infamous come from The Economist and Business Week.
In March 1999 The Economist proclaimed the beginning of a new era of low oil prices with the cover “Drowning in oil”. Meanwhile, two decades earlier Business Week ran a cover story highlighting how high inflation is destroying the stock market. The cover title read, “The Death of Equities.”
In both cases the magazines trend extrapolation came to an abrupt halt and went into reverse. It was a good time to buy oil in 1999 and a good time to buy equities in 1979.
In the same way that headlines tell us what we believe to be true, magazine covers and feature articles are often scheduled weeks or months in advance. For this to happen the trend has to have been in place for some time. The magazine cover can often be one step too far and so provide a contrarian signal to investors.
News sentiment and equity returns
Not all market moving news is made equal. The tone or sentiment of the news, whether positive or negative can have a big impact on market prices. And so this is where it gets interesting for an investor or trader with a relatively short time horizon. Analysis carried out by the IMF and the World Bank assessed the impact of media sentiment on global equity prices using more than 4.5 million Reuters articles published across the globe between 1991 and 2015. They found that changes in news sentiment can predict movements in both advanced and emerging equity markets over a period of a few weeks.
As you might expect they found that investors are more sensitive to global news sentiment (i.e. news affecting more than one country) during periods when the price of global equities are in a downturn. Investors typically weigh the prospect of losses much more heavily in their minds than wins. The research found that the impact of sentiment was four times more powerful in bear markets than bull markets.
The analysis also found that the content of the news varies significantly with the direction of global news sentiment. When sentiment is strongly positive, global news coverage tilts towards positive financial and corporate news in advanced financial markets, especially in the US. By contrast, the coverage tilts strongly towards economic and political news in emerging markets when the global news sentiment goes into negative territory.
Narratives are powerful frameworks by which investors can make sense of movements in the markets – bullish or bearish. What is clear is that in order to achieve better than average market returns you need to spot the narrative developing on the horizon, before the investing masses get wind of it. Be early, but not too early. As the great investor Jim Grant remarked, “Successful investing is about having people agreeing with you…later.”
Never wake up to the news
You’ve been asleep for five, six, maybe even eight hours if you’re lucky! One financial time zone has opened and closed while you’ve been in the land of nod. Something dramatic in the world might have happened that could affect your investments. You reach bleary eyed to your smartphone or switch on the TV. Just to check. Chances are though that nothing much has happened. The headlines from this morning probably won’t be important 17 hours later when you head back to bed.
But, that’s not what’s happened. The first headline you see makes you question one of your trades. Perhaps it wasn’t such a good idea anyway. In fact you begin to question why you were such an idiot for placing that trade. Before you’ve even had a chance to take a piss the cortisol levels are rising in your body. Right, that’s it I’m selling!
As I explain in Chapter 16, your state of mind affects how you perceive the world around you. Too tired, too irritable and lacking time to think makes for a serious headwind to thinking critically. Starting the day with a dopamine hit of market randomness and media sensationalism is just the thing to knock your state of mind.
Financial ‘chart’ crime
Recall from chapter 10 that an emotive image beside an article about some infectious disease heightens the perception that something bad is likely to happen. The same is true in the financial media. This time it’s not emotive images that get investors excited – but sexy charts. Yes, that’s right a good chart of financial or economic data.
I admit it I’m partial to a nice looking chart. FinTwit as its known is awash with people sharing their own charts and other people’s charts. One issue of course is that on Twitter tweeting one chart with 280 characters for context is not enough to illustrate all of what’s happening.
The bigger issue is chart crime. Not showing the axis at zero and using arithmetic scales when you should use a logarithmic scale, or vice versa. The worse though is adjusting the time period to suit the argument you want to make. This gives investors the perception that correlation, or the lack of it is a feature of the market when in reality a longer term context may reveal a very different picture.
Focus on your long term returns
We saw in Chapter 10 that the media spends an overwhelming majority of time reporting on things like terrorism and murder – abrupt causes of death that dominate the air time even though their occurrence is (relatively) few and far between. Yet the leading causes of death are heart disease and cancer. These everyday killers are with us all of the time, in the background. They are not news. The relative lack of attention may also be due to the longer time frames that these illnesses often take to play out.
A similar attention-deficit dynamic exists in the financial media, where the leading drivers of portfolio health (durable long-term returns) are often the least likely thing to be covered by the financial media. Those factors which affect long term returns are not news. For want of a better word they could be a bit, well…boring.
One of the hardest things about getting your financial news via Twitter is time. The time required to sift through and ignore the stuff that may be negative in the short term, but don’t really affect your investments in the long term. For example, if someone is a short term trader they may post why they are negative gold over the next few weeks, but that really shouldn’t bother you if you are planning to be long on the metal for several years.
How to be a smarter financial media consumer?
– The most important financial news and analysis is rare: The most important financial media content includes news and analysis that requires you to take immediate action. This should be extremely rare. Remember, the person producing the content doesn’t know you personally, or your portfolio. The second most important type of content changes how you think about an important topic.
– Be a financial news historian: It will teach you that the vast majority of headlines were not that important, and so not worth worrying about in the context of the time period important to you. It will also teach you that understanding headlines and their propensity to extrapolate trends can sometimes be an important indicator of a trend reversal.
– Consume financial media content that you disagree with, by people that you respect: The plethora of media channels available make it very hard to seek out alternative viewpoints. Seeking out well-structured arguments, even if you disagree with them enables you to gain a better understanding of the financial world that we live in.
– Imitate Ulysses – Investors should take the necessary steps to focus on the time horizon that is relevant to them. If a trade is based on your outlook over the next week then worrying about opinions in the media on the outlook over the next decade are useless; vice versa if you are focused on the long term.
By imitating Ulysses (whose crew bound him to the mast of his ship to protect him from the call of the Sirens), you could take steps to only be exposed to financial news relevant for the time period you are most concerned about. If that doesn’t work follow the example of Ulysses crew and put wax in your ears!
If you find yourself disagreeing with someone’s opinion over the future direction of a particular financial asset, ask yourself whether they are playing a different time horizon to you.
– Use the common knowledge game to understand narratives: Investors need to understand the underlying fundamentals of course, but what is even more important is that they also understand how narratives influence other investor’s behaviour. Always ask the question whether the narrative is now common knowledge, i.e. has it been ingrained into the investment process of other market participants?
– Be intentional about your financial news media process: Allocate a certain time of the day to review the news. Whatever you do don’t have news headlines popping up in real time or otherwise you will let that news define your process. Use a service like Pocket to save the best articles to read later.
This article is based on an extract from my recent book, “Pay Attention: 101 Ways To Tame The Narrative Machine, Be A Smarter Media Consumer And Stop Outsourcing Your Thinking