“Stories are narratives that unite us in belief and motivate us to achieve goals. No other animal can rally millions of its members to serve an abstract idea.”
-Dr. Richard Peterson
It’s a Thursday in August which basically means it’s Friday so here’s a fun little game:
You tell me a word that rhymes with “Orange” and I’ll grant you permission to continue reading and bask in the warm green glow of alpha-analytics below.
Ready, go!
Back to the Global Macro Grind…
If you’re reading this you are, of course, a cheater.
You’re also predictably human and you’ve probably told yourself a little story rationalizing why you should continue reading despite recreant noncompliance with the rules of the game.
Now, pocket your narrative rationalized transgression for a quick minute, we’ll come back to it.
Remember the LM curve? … the now maligned other half of the vaunted IS-LM curve - the classic, conceptual framework for explaining equilibrium between interest rates and output.
I always found the intuition around it lacking and was never able to really accept it as a core organizing construct.
I understood it in a kind of aseptic, theoretical sense but it seemed largely devoid of practical utility in divining short-term fluctuations in money demand or as a driver of interest rates over any investible duration? Why learn it (& continue teaching it) when even its creator has derided it as terminally flawed.
At this point, the LM curve has (arguably) been replaced by the MP (monetary policy) curve which basically just says that central banks set interests rates. It’s not perfect but it’s an infinitely more tractable construct for contextualizing macro activity.
The LM curve was just not a good story.
Narratives are uniquely and fundamentally human and it’s hard to believe that economics has – under primary and pervasive assumptions of rational agents, perfect information and utility maximization – evolved largely in a purposefully dehumanized echo chamber.
In their capacity to simplify and rationalize events and stimulate emotional response, narratives serve as powerful coalescing agents capable of driving virality, catalyzing or amplifying social mood or supporting trending prices.
It’s amazing that we’ve largely ignored narratives as impactful, exogenous factors capable of motivating and propagating action, reaction and inflections in markets.
And it’s all the more amazing given that monetary policy is inextricably rooted in “humanomics”.
Remember, the belief that your dollars have values is explicit acknowledgement of the power and central role of narrative economics.
The currency’s value is based singularly on the collective belief that everyone will agree to agree that is has value. Financial markets have become sophisticated and complex but fiat money – the exclusive facilitator of global economy activity – is simply a narrative based social convention.
Denying the import of narratives in shaping behavior and effecting outcomes is an exquisite exercise in willful blindness.
In our Macro Process, the Core Pillars have always been:
- History
- Math
- Behavioral Finance
And economists, psychologists and market participants are increasingly coalescing around ‘the narrative narrative’ and its importance in understanding network effects and “signal” propagation in social/economic/financial contexts.
The two links below offer some recent, advanced perspective on the role of narratives in economics and markets. The first is a guest post @Hedgeye by Dr. Richard Peterson (author of Inside the Investor's Brain). The second is a recent paper by Professor Robert Shiller presented at the 2017 American Economic Association annual meeting.
- Richard Peterson | The Psychology Behind Market Story-Telling Cycles
- Robert Shiller | Narrative Economics
Both are interesting reads and worth the short time investment but for our purposes here, let’s build on our headline quote and outline the key aspects of narrative driven sentiment in market cycles:
- Price trends develop when a single story rises to dominance. If the story makes us feel good, resonates emotionally and/or there is peer or media pressure to believe it, the magnitude and durability of impact increases.
- When fundamentals (& policy rhetoric) support cohesion in the prevailing narrative, price trends gain momentum. Here, it’s important to understand whether markets are trending higher along with sentiment and fundamentals, or whether sentiment has become untethered from the underlying fundamental reality.
- Volatility and opportunity emerge when a story is confronted with confusion or uncertainty. As Dr. Peterson describes, the resulting chaos can create a vacuum in which new stories and narratives take seed. Trump and Brexit are the obvious, recent examples.
It’s that last bullet that’s particularly important. Crescendos in sentiment associated with uncertainty are most prone to rapid reversal.
The other notable is that trending sentiment shifts have served as decent lead-to-coincident indicators for price shifts. It’s a psycho-behavorial phenomenon akin to sticky inflation.
Changes in the nominal interest rate translate to changes in the real interest rate in the short-term because prices don't adjust immediately.
Similarly, Confirmation Bias - in this case, our predisposition to discount or willfully ignore uncomfortable information - has an inertial effect.
As uncertainty rises the prevailing narrative comes under increasing stress with confirmation bias have an inertial drag on an inflection in sentiment. Resolution of that uncertainty allows for:
- Confirmation and reinforcement of the existing narrative
- Opportunity for a new organizing theme to emerge.
Of course, handicapping speculative extremes is difficult and quantifying uncertainty in a way that matters from an investment timing perspective is where the challenge of market non-linearity manifests.
North Korea wasn’t enough to shift the prevailing sentiment and price action. Neither was Venezuela. Is the constellation of Charlottesville + North Korea + Venezuela + Jackson Hole + Debt Ceiling + NAFTA + China/EU slowing + rising social angst + next Trump off-the-cuff antic the right milieu of factors that ultimately shifts sentiment?
It’s hard to know which snowflake will ultimately be responsible for the avalanche.
Beyond the importance of having a generalized model for the role of narratives in impacting market dynamics and prices, it’s particularly relevant here presently.
A third of the assets in our Key Macro Risk Range product are currently “neutral” (i.e. neither discretely bullish or bearish) from a Trend perspective, most are not threatening a breakout or breakdown from a Trade perspective, volumes (globally) are vapid, domestic macro has been benignly positive, the fundamental calendar has been light and 2Q earnings are now rearview.
When the Philly Fed survey and VIX seasonality are the lone headline and punditry talking points, it's a good indication we're in full narrative tread-water mode.
Moreover, the fact that the Bigger Picture setup (the specific mix of Central Bank Involvement, Demographics, Debt, Productivity, etc) has no great analogs only saps underlying conviction on Trend outcomes and elevates the role of trending narratives. History tends to rhyme but the current cycle may, in fact, be a macro Orange.
Further still, it’s difficult to maintain a convicted narrative or advance the plot when the protagonists have been conspicuously absent. Dragnet (Draghi & Janet, get it?) have already, successfully established the larger arc of normalization and have opted for rhetorical equivocation ahead of Jackson Hole.
Hurry Up and Wait for tomorrow has been the latest policy chapter and indications are that it’s likely to underwhelm.
That leaves us (again) with the Growth and Inflation forecast and quantitative risk management process as the principle allocation drivers. And you know where we stand on the 2H growth and inflation outlook and can see where we stand from a positioning perspective in RTA and the asset allocation model.
When nothing’s going on, keep moving. Be the change you want to see.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.14-2.26% (bearish)
SPX 2 (bullish)
RUT 1 (bearish)
NASDAQ 6 (bullish)
DAX 116 (bearish)
VIX 9.99-16.16 (bearish)
USD 92.68-94.01 (neutral)
It’s hard to start a movement if you’re standing still!
Christian B. Drake
