The Narrative Fails

Its Friday (and a hot summer Friday at that), and as such, I like to wax philosophical about what I see around me as some of the broader issues today.

Cullen Roche of Pragmatic Capital sets the scene for us:

“The economy continues to do okay, the stock market is hitting all-time highs every day, real estate is back on the up and up, interest rates remain very low by historical terms, the net worth of Americans is back at all-time highs, we’ve just dragged ourselves out of the worst recession in 80 years, but people are still upset about a lot of things . . . I have a feeling that there’s more to this general unhappiness than meets the eye. And I think a lot of people are mad because the fear case has totally lost out at this point.”

He is precisely correct: A large source of angst is from those who missed the 146% rally to all time highs. Sell offs can be painful, but the mathematics of mean reversion are inescapable. Asset classes eventually recover, but if you fail to participate in a generational rally, it will haunt your compounded returns forever. Cullen implies that (beyond high unemployment) this might be the source of this angst.

But there is a deeper, more fundamental reason for the unfocused rage and misdirected anger: The failure of the narratives that have been driving much of economics, investing and politics. As John Kenneth Galbraith famously said, “Faced with the choice between changing one’s mind and proving that there is no need to do so, almost everyone gets busy on the proof.” Rather than accepting certain unpleasant realities, many participants have contorted themselves into a painful waiting game. They are “busy on the proof.”

The Galbraith quote reflects a favorite topic of ours — Cognitive Dissonance — and we have spilled more than a few pixels in these pages on the subject. As many of the narratives have failed, rather than admit the error and face the music, the rationales have morphed into a waiting game. Dow 5000 will happen eventually, Collapse of the Dollar — and all fiat currencies — is coming; Hyper-inflation (any day now), Gold will hit $10,000 (sold to you), Great Recession 2, Oil $200, etc.  The reference is not to any one of these errors specifically, but rather, tot he entire narrative driven belief systems in general. They are by design money losing stories, either torturing the data or ignoring it entirely.

Cullen gets more specific than I do in The Narrative Failing — he calls it The Fear Trade Has Been Demolished:

“If you’ve been paying attention over the last few years, you probably remember how many people predicted hyperinflation, surging bond yields, soaring gold prices, a cratering US Dollar and a collapsing stock market. This was the fear trade. You overweight gold, short US government bonds, short the USD, short equities and laugh all the way to the bank. Parts of that trade have worked out OKAY (like the gold portion over the years), but on the whole that trade has been a big disaster. In other words, fear lost out – again.”

Here is where the rubber meets the road — the specific cognitive reaction to the narrative failure:

“A lot of people who bought into the fearmongering nonsense are angry. They’re angry because they backed their political beliefs with their wallet. They’re angry because they listened to so-called “experts” peddling their political beliefs as an understanding of the monetary system. They’re angry because they read scary websites that claim to have predicted the crisis, but have gotten almost everything wrong since 2008. They’re angry because they let their emotions get in the way of sound analysis.”

And that is what cognitive dissonance is all about. Its coming up short in your forecasts, and making all the usual excuses. Its rationalizing why you are right and the markets are all wrong. Its doubling down on the bad trades, despite the obviously failure of the original thesis. Its sticking to your story no matter what the facts are. “Who you gonna believe, me or your lyin’ eyes?

It is the triumph of narrative over planning, ideology over facts, politics over data, emotion over intelligence.

I see this everyday in the office. We speak with potential asset management clients who have this false understanding of the world, and we have to deprogram them from their diet of fear-mongered narrative driven insanity. I’ve looked at $100 million+ foundation money sitting in 50% TIPs, 50% Cash (nothing else). We keep seeing  portfolios that are mostly junior gold miners and currency bets.

How is this for an astonishing but by no means surprising data point: In self-directed 401(k) plans, “The biggest single equity holding was Apple (AAPL) . . . followed by the SPDR Gold Trust (GLD), an exchange-traded fund.” (US News, 2012)

All of these trades represent the same cognitive foible: Investing by a well told if erroneous and unsupported story. And now, that Narrative has failed. The more adaptable, enlightened investors are learning the errors of their ways.

What narrative are you following?



UPDATE: Josh sends me the link to Greg Harmon’s similar take here: You Have Been Calling for A Crash for 6 Months and Been Wrong, Now What?


The Cognitive Dissidents (November 14th, 2011)

The Dangers of Non-Modeled Narrative Story Tellers (December 3rd, 2012)

Why don’t bad ideas ever die? (December 16 2012)

Rise of the Empiricists (January 29th, 2013)



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