Popular narratives shape our shared investment sentiment
• The stories we tell ourselves, rather than economic feedback, are used to predict performance
In the abstract to Narrative Economics, the paper he published earlier in 2017, Nobel prize-winning economist Robert Shiller points out that we have always been highly tuned towards narratives, whether factual or not, to justify ongoing actions, even such basic actions as spending and investing.
“Stories motivate and connect activities to deeply felt values and needs,” says Shiller. “Narratives ‘go viral’ and spread far, even worldwide, with economic impact. The 1920-21 Depression, the Great Depression of the 1930s, the Great Recession of 2007-09 and the contentious politicaleconomic situation of today are considered the results of the popular narratives of their respective times.
And though these narratives are deeply human phenomena that are difficult to study in a scientific manner, quantitative analysis may help us gain a better understanding of these epidemics in the future.”
Elsewhere in the paper Shiller suggests we consider “the possibility that sometimes the dominant reason why a recession [or other economic event] is severe is related to the prevalence and vividness of certain stories”, rather than “the purely economic feedback or multipliers that economists love to model”.
In 1742, David Hume wrote: “When any causes beget a particular inclination or passion, at a certain time and among a certain people, though many individuals may escape the contagion and be ruled by passions peculiar to themselves; yet the multitude will certainly be seized by the common affection and be governed by it in all their actions.”
The psychologist Jerome Bruner, who also stressed the importance of narratives, said he did not believe facts “ever quite stare anybody in the face”, but that “our factual worlds are more like cabinetry carefully carpentered.…”
If that’s true, the news media would certainly have a role to play in the process. Unfortunately, little attention has been given to the influence of news stories, says Shiller.
By way of example, in a Neubauer Collegium director’s lecture on Narrative Economics, Shiller held up that morning’s headline in the Wall Street Journal, which read “Dow Tops 20,000”.
“In reality, this is absolutely meaningless,” he says. “The Dow started at 40 points in 1896, but hey, they could have started at 50 or something else. So, it’s a joke .... And then in the second paragraph they link it to another narrative: Donald J Trump. This is something that you are trained to do in journalism school … it’s part of what Akerlof and I call ‘phishing equilibrium’ — within limits you’ve got to phish – you’ve got to play the game.
“The other thing that strikes me [in the article] is it says ‘whoops and cheers erupted on the floor of the New York Stock Exchange as the market closed’. Now, do you believe that? These guys on the floor of the NYSE aren’t stupid. They knew it was just a number that was made up, that the Dow hitting 20,000 wasn’t as a result of some new level of fundamental market soundness. But the story wasn’t about the market being fundamentally sound; it was a story about a number, and about the people around that number.
“Then you have to reflect that the whole floor of the New York Stock Exchange is just a trick,” Shiller went on to say. “We’re into electronic trading now, so why do they even keep that? Well, they keep it because it’s a narrative, right? People come to New York, they want to see the New York Stock Exchange, and so they can go to the visitors’ gallery from which they can take lots of pictures.”
By way of agreeing, “if you step back and think about it, it’s tricky to find a rational reason for all the excitement”, says Elizabeth Harris in a Forbes article. “After all, there’s little mathematical difference between Dow 19,000 and Dow 20,000 — on a percentage basis, the move between, say, Dow 15,000 and Dow 16,000 was much more significant. Historically, the Dow isn’t much of a barometer, either. The famous industrials index is actually a semi-arbitrary basket of 30 stocks that includes companies as varied as tech titan Apple to Wall Street goliath Goldman Sachs, and it changes every few years. So, given all this, why do we care so much about Dow 10,000, 15,000, 20,000 and all the ‘milestones’ in-between?”
Her answer: “Blame it on what’s called the ‘availability heuristic.’ That’s the psychological tendency to use the recent past (we just hit a milestone!) as a barometer of what will happen in the near future and overweight the importance of what’s happened in that recent past (the market is rising).
“Also at work is confirmation bias, where we tend to embrace ideas, facts or, in this case, market performance that agree with our own point of view. After all, who doesn’t want the market to rise? So the Dow crossing 20,000 must be a meaningful event, right? When you think about it rationally though, you realise that milestones of this type offer little or no proof of another milestone approaching — or not approaching.”
Despite its statistical and historical meaninglessness as a predictor of near-term stock performance, Dow 20,000 will still have a psychological effect on markets, says Shiller.
“Speculative markets have always been vulnerable to illusion and seeing the folly in markets provides no clear advantage in forecasting outcomes, because changes in the force of the illusion are difficult to predict,” he says.
One of the most important narratives in US culture is the crash of 1929, writes Shiller in the Chicago Booth Review. “And I’ve been asking, in a survey of individual investors, for people to estimate the probability of a stock market crash like those we saw in 1929 or 1987, the two biggest crashes in US history.
“I’ve been collecting these data for close to 30 years, and even though we’ve had just two of these crashes in more than a century, both individual and institutional investors consistently exaggerate the odds of seeing one within six months of their survey response. They tell me the probability is 15%-20%. Strangely enough, investors’ estimates were low ... just before the 2008 financial crisis.
“The 1929 Wall Street crash is a terrible story but a memorable one. It is widely seen as marking the beginning of the Great Depression. Twenty-three percent of the US population became unemployed by 1933. There were lots of people standing in bread lines … and we’ve been worried about it happening again all this time, because the narrative isn’t forgotten.
“There are so many other episodes ... that we could be talking about, but apparently those stories just weren’t as viral and are largely unnoticed.”
Extract from an interview with Robert Shiller last week at Quartz:
Quartz: Are your feelings on the stock market based on the CAPE ratio?
Shiller: The CAPE ratio is just one indicator .... Since 1989 I’ve been doing questionnaire surveys of both individual and institutional investors .... I believe in it, somewhat, though I don’t think it answers everything.
I have something I call a valuation confidence index. I don’t have it really up to date because it’s only a six-month moving average based on small surveys. But valuation confidence is at the lowest it’s been since around 2000. In other words, people think the market is highly valued. Both individual and institutional investors. We are in a time of mistrust of the market.
The only time mistrust of the market was lower since 1989 was in 2000. So around 2000, the peak of the dotcom bubble.
It seems like the mind-set is somewhat similar to the dotcom mind-set. And that brings us to the Fangs [Facebook, Amazon, Netflix and Google] as well.
Hi-tech companies are probably more exciting, as they were in 2000.
The year 2000 was kind of like 1849. That was the gold rush. It really created a viral explosion of men going out west looking for gold. Now is the time, you certainly can’t wait until 1850! You have to do it now! It was the same thing in 1999 or thereabouts, when stories of some internet companies were coming out and people said, ‘you know, this is the future, these guys are going to take over’.
Usually these stories have an element of truth to them, but the question is how fast is it going to happen and what’s a realistic view for investors.
And they got ahead of themselves with the dotcom bubble. We’re maybe doing that again with the Fangs.
YOU HAVE TO REFLECT THAT THE WHOLE FLOOR OF THE NEW YORK STOCK EXCHANGE IS JUST A TRICK