Investment Narratives
Shared beliefs fill our lives in a variety of forms - religion, politics, sports, news etc. An area that has become increasingly difficult to navigate is shared beliefs around money. I describe "investment narratives" as the stories and shared beliefs people build up enough conviction around to make an investment decision on.
“To understand the way financial assets are valued we must realize that, in essence, what is being traded are stories – competing imaginative accounts about the news and its impact on an uncertain future”
- David Tuckett, University College London
Admittedly, this is a rather obscure topic and focuses mostly on the psychology of investing. I will share my approach and tools that may help you think critically about your future investment decisions - especially when you are relying on the opinions of others.
Causal hypotheses
To get started you must first appreciate that most investing narratives take the form of causal hypotheses. A causal hypothesis is one that suggests that a cause-and-effect relationship exists between variables. A simple example would be "raising gas prices causes an increase in the number of people who carpool to work." On the surface it sounds like a reasonable cause-and-effect relationship but drivers may actually be insensitive to the gas prices because they value comfort, convenience and privacy more. While usually intuitive and logical, the causal relationship is not always accurate or predictive.
It is important to be aware of two serious problems that arise when using causal hypotheses in investing. One is that very little effort is made to seriously test the hypotheses. An even bigger problem is that people do not develop their own hypotheses - they act on those heard on the news, from friends, family or even strangers. It is important to be conscious of investing ideas that are not your own.
“Interest rates are low, so stocks only go up...”
“Inflation is coming because the fed is printing money...”
“The Yuan is the next global reserve currency because China is growing fast...”
Do any of the above investment narratives sound familiar to you? Do you believe any of them to be true and if so do you have any independent analysis to prove that they may be true?
Post-truth is not new
As of late, it has been fashionable to claim that we live in a “post-truth” era where the focus on “shared fictions” is a problem in society - the idea that objective facts are less influential in shaping public opinion than appeals to emotion and personal belief.
There is also the prevailing notion that this “post-truth” is a new phenomenon brought on by the internet - social media websites amplifying opinions and spreading them at a rate and in a form that has never been experienced before.“Post-truth” was even named word-of-the-year in 2016 by Oxford Dictionary.
The word post-truth may be newer, but the core ideas behind it are not.
Philosophers and historians have long debated whether shared beliefs have helped or hindered humans as they cooperate and conquer the planet.[1] I’ve listed works below by prominent thinkers from over 100 years ago which readily prove that humans have lived in the post-truth long before the internet. (All of the works are freely accessible thanks to Project Gutenberg and I have linked each title.)
- “The Will to Believe" (1896) by William James
- “The Will to Doubt” (1907) by Alfred H. Lloyd built upon by Bertrand Russell in “Free Thought and Official Propaganda” (1922)
With this idea that post-truth is nothing new, it has a few loose synonyms going back further than 2016. One of these is “propaganda” however using that word openly is a faux-pas - it has an accusatory tone. It implies the information is fictional, self-serving and that someone or some institution is responsible for its purposeful distribution and mode of replication.
Instead, I regularly use the word “narrative,” which is a less egregious synonym. “Narrative” does not imply some devious third party and can arise innocently or spontaneously through word of mouth or some other method giving rise to its spread.
If post-truth has existed for so long and in so many parts of society, it seems reasonable that investing is not immune. What’s important to understand is that a narrative is just a story or an idea that can, but will not always be supported by rigorous analysis.
Memetic nature
I believe investment narratives primarily spread through memes. A meme acts as a unit for carrying cultural ideas, symbols, or practices, that can be transmitted from one mind to another through writing, speech, gestures, rituals, or other imitable phenomena with a mimicked theme.[2] Put simply, a meme is a sticky idea that replicates and spreads.
In David Deutsch’s eccentric book “Beginning of Infinity”, he presents his two modes of meme replication, “rational” and “anti-rational”. While I am critical of many of Deutsch’s ideas, I have profound respect for his work in philosophy and quantum computing. I also find separating investment narratives by these two modes of replication to be a practical exercise that is incredibly useful.
Both rational and anti-rational memes are sticky but achieve their stickiness through opposite methods.
Anti-rational memes achieve their stickiness by depriving the holder of the ability to criticize them - an entrenched authority diverts away criticism. These memes thrive by disabling the capacities of their hosts (by means of fear, or an anxiety to conform, or the appearance of naturalness and inevitability, or in any number of other ways) to evaluate the truth. Because it is a meme, it also compels the holder to spread the meme to others. An important clarification here is that an anti-rational meme is not an idea to be considered harmful. Ie. an anti-rational memes are not inherently “bad”.
A rational meme is the opposite - it thrives in a critical environment because it is true and useful. it is one that survives criticism, not disables criticism. A rational meme reproduced faithfully because it is being criticized. The criticism itself is what makes the meme sticky.
The optimist in me likes to believe that an investment narrative that spreads as rational meme leads to a more successful investment in the long-run.
Three tests of investing narratives
Over time, I have developed a basic framework for identifying and evaluating investment narratives. I’ve simplified my framework into a series of tests as follows:
- The “Tupperware Party” Test
- The “Smart-speak” Test
- The “Call to Arms” Test
1. The “Tupperware Party” test
The first test focuses on whether the one sharing the narrative stands to gain. I call this test the Tupperware test because we are often sold investing narratives in social interactions. Are you being sold the idea?
Tupperware is a home products line that includes mostly plastic storage products for the kitchen and home. Hosts and hostesses of Tupperware parties were rewarded with free products based on the level of sales made at their party. They rose in popularity during the 1950s and parties took place in workplaces, schools, and other community groups. They of course were subsequently criticized as multi-level marketing programs amounting to a pyramid scheme.
This test is most important because the communication and spread of investment narratives are near impossible to regulate. Even if a disclaimer is shared ex. "this is not investment advice", the information that follows can lead an individual to generate an implied causal hypothesis.
When investment professionals or portfolio managers freely share information, it is wise to always assume they are "talking their book". Are they sharing the information because they genuinely believe in their analysis or are they sharing it to convince you to buy an investment they already own ie. already have in their "book". If they already own the investment, they stand to profit if you also buy it - demand increases and therefore price increases. Usually, really good investment ideas are proprietary and are not freely disseminated.
Tupperware is largely a fun and harmless exchange but some narratives are not.
3. The “Smart-speak” Test
Is the narrative understood, or does it just sound “smart”? Can you tell if someone is sharing an original idea or analysis of an existing idea? As previously explained, if investments are spread through memes, there will be individuals who spread ideas without understanding them. I genuinely don't have an explanation for this phenomenon but it happens often. Maybe individuals share investment narratives to carry conversations or to impress their colleagues - I am not sure.
If the narrative is not within your domain, get a second opinion from an expert and get it explained to you simply. If you still don’t understand it, try to refrain from having a strong opinion on the matter or if you must, have an opinion that is very loosely held.
3. The “Call to Arms” Test
Does the narrative appeal to emotions? Is it presented in a way to incite a strong positive or negative reaction? This test also attempts to identify ant-rational memes - does an entrenched authority divert away criticism from the narrative? Anti-rational memes around investments are commonly perpetuated by large institutions for profits or governments to sustain macroeconomic goals. While they may be beneficial in aggregate and at scale, they may not be the best investment decision for you as an individual.
Putting it all together
All three tests lead to critically thinking about investing narratives. You may be seeing some red flags if someone stands to gain, doesn’t understand the idea they are perpetuating, or is trying to appeal to emotions from a position of authority.
After identifying a narrative, it is important to build your own thesis and test against it - similar to the “the scientific method”. The only difference is that the nature of investment narratives make them difficult to experiment on.
While I am a proponent of this approach, proving causality can be both (a) impractical, especially without sufficient data, and (b) time consuming. Investments usually involve large sums of money and your livelihood so striking a balance is key.
The goal is to determine whether the narrative is likely fiction. A nuanced point here is that the onus is on you to prove that the narrative is false. Seek disconfirming evidence. Before proceeding, you must see the validity in both sides or you will struggle to work with narratives.
“I never allow myself to have an opinion on anything that I don’t know the other side’s argument better than they do.”
- Charlie Munger
One added benefit that I’ve found using this method is that I am more confident with any investment decisions based on my thesis. If I have proven or disproven a narrative with my own research, I am less likely to change my mind based on anything other than my thesis being disproven. I find "panic selling" to be a less common occurrence leading to a strong portfolio in the long term.
Some caveats
I have proposed a framework for identifying investment narratives and assessing whether the underlying facts are strong enough to rely on. The question that often arises: "Is investing is weak narratives a bad idea?" I feel the need to include a few caveats here because the answer is complicated and "it depends".
1. Riding waves
I am not suggesting that strong narratives be avoided, I am sharing why proving causality should be part of your process.
I would like to stress here that underlying facts just need to be “strong enough” based on your risk tolerance and the above noted factors (ie. practicality and time). In the end however, the wave can be so strong that the underlying facts don’t matter on the path to success. Investments with this characteristic are usually risky in nature - if they catch you off-guard it is because you did not assess the risks correctly upfront.
While it is possible to follow a narrative blindly, follow correlation or “ride the wave,” it then becomes a matter of timing and whether you can exit positions before any narrative shifts. I have noticed empirically that weak narratives are more likely to shift dramatically.
2. Market microstructure and self-fulfilling prophecies
Narratives are not always factual just because some arbitrarily accepted metric for success is true. Most often, society associates over-bought assets as being a success because of price increases. A simple example is “Bitcoin is a success because the current price of an individual bitcoin is high”. Unfortunately, this is a fallacy.
Sometime narratives make the switch from being based in fiction to reality simply through the mechanisms of self-fulfilling prophecies. A potential example today is the ever-prevalent inflation narrative.
Disclaimer: This article is opinion and is for information purposes only. It is not intended to be and should not be considered as investment advice. Seek a duly licensed professional for investment advice. Opinions are my own and not the views of my employer.
Footnotes
[1] Yuval Noah Harari. Are we living in a post-truth era? Yes, but that’s because we’re a post-truth species. ideas.ted.com. 2018
[2] Graham, Gordon. Genes: a philosophical inquiry, New York: Routledge, p. 196, ISBN 978-0-415-25257-7. 2002