Narrative drives Price drives Narrative
Why it's important to separate the two and see reality for what it is
‘Narrative drives price’ is the natural order of things. It’s the process that happens all day in financial markets. Something happens, experts figure out what it means for a security, and its price reacts.
But it also works in reverse. Price tends to reinforce narrative. If a stock is up 10x and you’re short, you’re the outsider. If people listen at all they’re as skeptical as they would be listening to a UFO believer (until recently, anyway). But an evangelist gets taken more seriously, because what they’re saying is consistent with recent experience.1
Price vs. narrative also makes for some quality meme material:
And this one is a personal favorite:
This dynamic makes sense if you think the market is efficient. For the lazy, price becomes a proxy for research. Stock is booming? Business must be great, this is a compounder. Buy. Stock is crashing? Business must be terrible, this has secular issues. Sell.
You see this happen every day as the media scrambles to explain hour-by-hour price changes. The underlying assumption is that there is a good explanation for the change in price. But as Ben Graham explained, in the short run the market is a voting machine, not a weighing machine. It often over- (or under-) reacts, with price set by supply and demand.
So it’s all circular. And when price gets disconnected from fundamentals, so does narrative, sometimes leading to a price/narrative that’s divorced from intrinsic value. GameStop and the other meme stocks are extreme examples, but I think this happens on a smaller scale all the time.
The investment business loves the word “narrative”. Merriam-Webster defines it as “a way of presenting or understanding a situation or series of events that reflects and promotes a particular point of view or set of values“. The last bit is important. A narrative is one interpretation of reality. It’s a version of the past and present, often lazily extrapolated into the future.
Narrative comes with an agenda. The media likes to sensationalize for attention-grabbing headlines. Investors talk their book. And so on. Take this one example from @WallStCynic yesterday, tweeted while watching the news. Nobody likes a narrative violation - especially when the narrative is widely accepted.
The price/narrative dynamic makes it hard to see reality for what it really is. We’re subject to countless biases as our brains construct imperfect models of the reality we’re surrounded by, yet can’t experience directly. This usually doesn’t matter. Our eyes and brains are good enough to construct a model of a staircase that’s accurate enough so we don’t stumble when we go up stairs (and that has to be pretty close).
But investing (just like all knowledge work) is abstract. Our brains have to work harder to build that model, and it isn’t as accurate as the staircase.
It’s also impossible to invest well without seeing reality clearly. How can you forecast the future of a company, industry or asset class without seeing the present clearly? I think we can apply much more discipline to how we study the past and present. Investors often jump straight to a forecast—an inflection point—taking the present as a given. As V.S. Naipaul tells us, the present foretells the future. If we applied a more disciplined approach to the present, the future becomes less hazy.
“I believe the present, accurately seized, foretells the future.” - V.S. Naipaul
Price drives narrative as much as narrative drives price. But a narrative is just the past and present interpreted through one, biased lens. Using that as a basis to form views about the future is dangerous. We’d do better with a more disciplined study of the past and present, considering more than one narrative with explanatory power. If we can do that, the future comes into focus.
I think this particular situation is an exception to the dynamic Morgan Housel describes as “The Seduction of Pessimism”, in his excellent book The Psychology of Money.
"Man is not a rational animal; he is a rationalizing animal."
I have been spending a lot of time thinking about this topic as well. One of my favorite history authors, Graeme Snooks, writes about history through this perspective. People will do whatever seems to make their life better. Some people find more effective ways than others, which society at large imitates and constructs a narrative (through culture & institutions) for why it makes. At the macro-scale Roman culture was built around war, Greeks' around trade, Americans' around technology because those 'cultures' made them better off.
As you begin to realize that human's have this insatiable desire to rationalize what's happening -- through political, cultural, religious, and economic stories -- you become skeptical of any one story. The easiest way to discover reality is to question the basis of belief and compare alternative explanations. Unfortunately, that is also the hardest thing for humans to do, especially when their self-worth is wrapped up in their beliefs.