I recently read Will Storr’s excellent book ‘The Science of Storytelling’[i]; which is an exploration of how our brains process stories and why they are such a fundamental component of human experience. Whilst it is primarily designed as an aid for writers seeking to better craft their narratives; for me, it also served to underscore the underappreciated but essential role that stories play in financial markets.
Linking storytelling and investments is not a revelatory observation – investors are often lured into a poor decision by a compelling story and no financial bubble in history has been absent some beguiling narrative – however, their importance is hugely understated. Rather than a susceptibility to stories being a behavioural quirk; the human brain’s reliance on narratives to make sense of the world means that they define much of our investment behaviour. The noisy, chaotic and unpredictable nature of financial markets is anathema to our mind’s desire for order and clarity; stories reduce our discomfort and allow us to navigate the ever-capricious waters. It seemingly matters not that most of the yarns we spin are works of fiction.
Storytelling in financial markets is always driven by cause and effect. There are two forms of this – either we predict a cause and effect before the event, or we look to rationalise an effect by defining a particular cause subsequent to the occurrence. Although we might not always consider them as such both of these scenarios are about creating narratives – Y will happen because of X, or Y has happened because of X. Investors do this for every conceivable situation – from justifying the hourly change of a stock price to the impact of a fifty-year demographic shift on asset class returns. Everything must have a cause and effect underpinning the narrative.
In many other circumstances a straight and true line can be drawn between cause and effect – even if something might not be forecastable, it can be understood after the event. We might not be able to foresee a plane crash; but in most cases we have sufficient information to gauge its cause after the incident. Unfortunately, in the random and reflexive world of investment, accurately defining these aspects in either predictions or during a post-mortem is hugely problematic. We know only too well about the hopelessness of forecasting and observe on a daily basis the myriad competing explanations for even the most irrelevant market or economic change.
If gleaning cause and effect in financial markets is so difficult, why do we spend most of our time talking about it? As Storr succinctly notes: “Cause and effect is the natural language of the brain. It understands and explains the world.” The alternative would be to exist in a financial environment defined by randomness and chaos – whilst this may be closer to the reality, it would not make for a comfortable existence.
In addition to the importance of cause and effect for our narrative-driven brains; Storr also highlights how the types of stories we tell are dependent on the mental models that we develop and then seek to defend. This has unquestionable relevance for investors – we all utilise models for interpreting the financial world; these can be structural (I might be a Keynesian economist) or temporary (I might be bullish on equity markets over the next six months). The belief sets that we maintain mean that when we create our stories we do so in a prejudiced fashion; as Storr explains: “Our storytelling brains transform reality’s chaos into a simple narrative of cause and effect that reassures us that our biased models…are virtuous and right”.
The importance of these models to our sense of identity means that much of our tale telling is in the defence of those models. Financial market participants are not coolly and impartially attempting to identify cause and effect; rather we are creating stories that corroborate our views and our beliefs, and often rail against those with conflicting perspectives or opinions. We see this constantly in the varied and often entirely contradictory interpretation of the latest release of economic data. If you understand an individual’s angle, mental model or incentive, then you are likely to have a good idea of the story that they may tell.
Does the importance of narratives in how our brain interprets the world mean that investors are condemned to exist in an environment of incessant, often meaningless and always biased storytelling? To an extent, but it depends on how much we choose to engage. Financial markets provide an unrelenting torrent of outcomes which we can seek to forecast or explain via stories – indeed, much of the industry is fuelled by these precise activities – and whilst the notion of storytelling seems harmless, for investors it is likely to mean over-trading, over-confidence, stress and partiality. Investors need to be comfortable stepping away (it doesn’t matter what the market did yesterday or why), be willing to say they have no idea what will happen or why it happened; and focus on some robust, evidence based, principles – all supported by a good story, of course.
[i] The Science of Storytelling by Will Storr