Editor's Note: Below is a brief excerpt from today's Early Look written by U.S. Macro analyst Christian Drake. Click here to learn more about the Early Look.
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.
In our Macro Process, the Core Pillars have always been:
- History
- Math
- Behavioral Finance
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.
- When fundamentals (& policy rhetoric) support cohesion in the prevailing narrative, price trends gain momentum.
- Volatility and opportunity emerge when a story is confronted with confusion or uncertainty.
It’s that last bullet that’s particularly important. Crescendos in sentiment associated with uncertainty are most prone to rapid reversal.
