Investment View: Buying the story too often means believing fiction
Few will admit error and face the music. Instead, they double down and make further bets
Tuesday 30 July 2013
It is in our DNA to love a good story. You know, neat tales with heroes and villains and conflicts to resolve. A good story pushes our buttons, is exciting and memorable. So it should come as no surprise that Wall Street also loves a good story. And when Wall Street spins a yarn, its emotional pitch drives sales.
In the parlance of the Wall Street brokers, these are “story stocks”. You have heard them: a new CEO is bound to turn the company around; the FDA is about to give Phase 3 approval to a miracle drug with a billion-dollar market; a sexy new product launch is going to catapult the stock price. And everyone’s favourite fish tale: the imminent takeover play.
Of course, many of these stories turn out to be wrong. But that’s not what gets us into trouble as investors. It doesn’t matter whether a story is true or false. It might be counterintuitive, but even true stories can end up being money-losers.
What matters most to you as an investor is the concept of the narrative. You have a natural tendency to want an emotionally satisfying tale – and to make investments based on that – despite times when the actual data may be telling you something different.
Consider the gold price narrative – it was going to hit $5,000 an ounce because of the Fed’s quantitative easing. Well, the Fed is still doing QE but gold has fallen as much as 30 per cent. Guess they need a new narrative.
How many people have been calling for a market crash for several quarters now, if not years? Cullen Roche of Pragmatic Capital describes what may be the biggest narrative failure: the Fear Trade. “You probably remember how many people predicted hyperinflation, surging bond yields, soaring gold prices, a cratering US dollar and a collapsing stock market,” he says. “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. On the whole, that trade has been a big disaster. In other words, fear lost out – again.”
He is right: none of those things has come to pass. Even worse, the fear traders have missed a 150 per cent rally in the US stock markets to all-time highs. While sell-offs are painful, over the long haul they tend to be temporary. The maths of asset classes means reversion is inescapable. Stocks will eventually recover, but if you fail to participate in a generational rally of this magnitude, it can set back your retirement by up to seven years.
Perhaps there is a deeper reason for all the angst. We have witnessed the same sort of narrative failure in other fields as well. It is rife in economics, where the austerity narrative has all but collapsed. In politics, the supposed class battle between makers and takers never materialised. Even in climate change, a number of sceptics eventually gave up on their arguments as the data overwhelmed the conspiracy narrative.
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”.
This is why I do my annual mea culpas. The reality of life is that everyone is wrong on a regular basis. By confronting these inevitable errors, you allow yourself to make corrections before it is too late. Traders are fond of the aphorism, “It’s okay to be wrong, but it’s unacceptable to stay wrong.”
And expensive as well. Few are willing to admit error and face the music. Instead, they double down and make further bets. “I am not wrong, just a little early!” is the hopeful mantra. The Dow will eventually sink to 5,000. The dollar will eventually collapse (along with the rest of the “fiat currencies”). Hyperinflation is just around the corner. Gold is going to hit $10,000. Don’t blame me when the Great Recession II comes!
It’s not that any of these things is specifically wrong – they are all possible outcomes – but rather, the problem is the reliance on narratives that are by design money-losers, torturing the data or ignoring it entirely.
It’s clear when emotional storytelling gets in the way of intelligent investing. All of this is based on sticking to a story no matter which facts present themselves.
I call this the triumph of the narrative over data, ideology over intelligence, politics over facts, emotion over planning.
Here is my favorite astonishing (but by no means surprising) data point: as of the middle of 2012, in self-directed US personal pension plans, the biggest single equity holding was Apple … followed by the SPDR Gold Trust, according to US News.
That’s what you get for investing by a well-told, if erroneous and unsupported, story.
What narrative are you following?
Barry Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, The Big Picture. Twitter: @Ritholtz
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