The power of story

As human beings, we are hardwired to apprehend the world through stories.

Stories are how our memories are stored, how we put facts together. Stories are always linked to primary emotions, always interconnected, hence our tendency to apprehend the world through causality and our incapacity to accept uncertainty and randomness.

Stories are what define us as individuals and as people. Man’s search for meaning and the narrative process are at the core of our psychology, but also the roots of every religion, culture etc.

As Reynold Price wrote“A need to tell and hear stories is essential to the Homo sapiens--second in necessity apparently after nourishment and before love and shelter. Millions survive without love or home, almost none in silence; the opposite of silence leads quickly to narrative, and the sound of story is the dominant sound of our lives, from the small accounts of our day's events to the vast incommunicable constructs of psychopaths."

Stories are essentially what make us human, what link patterns with other patterns and give us that sense of perspective, give context to the text, connect the dots, and as such put order into chaos, turn noise into signals. Stories give that sense of direction, that vision of how the present situation will evolve in the future and ultimately what direct our actions.

Therefore, if you want to understand the direction of a stock, look no further than the respective power of its story.

I am always amazed by how addictive stories can be and how very little can be learned whilst hearing the anchorperson post justifying the latest market move with the most spurious story of the day and within an historic perspective never longer than two hours. One day, one can hear “the Dow Jones Industrial fell by hundred points, as higher oil prices are weighing on consumer sentiment”. The following day, “ the Dow Jones Industrial rose hundred points, as rising oil prices drove oil stocks higher”. Same cause, opposite effects…?

This is the noise investors have to deal with every single day. Noises as the same cause driving opposite effects and other correlations between the size of women’s dresses and pork belly futures. These stories do very little in terms of explaining the intrinsic drivers of the trend or catalysts for change at work. Correlation is not causation.Yet we listen, watch, pay attention and sometime even believe these stories revealed the truth.

As a matter of fact, who knows if there is a cause at all? For what I know, the stock market has 55% chances of going up and 45% chances of going down every single day, so not far from the odds of a coin flip. Aren’t we, as Thaleb put it, just fooled by randomness?

Let’s not enter into this debate here, but just focus on the why. Why do people feel like they need a cause and reason behind every market move? Every parent knows that between the age of 3 and 6 their kids ask the question “why?” again and again.  Every answer is an excuse to bounce back with the same question over and over again. Why? Why? Why?

The answers have to be credible, but do not have to be true. In fact, most parents, when pushed to the boundaries of their knowledge of the universe or unsure whether their kids can accept the sad disenchanted truth of our human conditions, would make up any answer just for the sake of having their child sleep well in the belief that the world is ruled by some kind of enchanted order and everything around them has a cause.

Even if the order is magical, it seems more acceptable than the sadder unemotional statistical truth that some things are what they are or happen because they do and that the future is uncertain because we do not know everything and that everything changes. The Bible or the story of an apple falling on Newton's head is far easier to tell and remember than recalling what happened to Schrodinger's cats or that the universe might be ruled by order and power laws at a macro level, but ruled by chaos and randomness at a micro level, even if that window of chaos might be the only shot we have at free will.

Like children, most investors like to see a logical explanation behind every market move. They rarely accept randomness. People want to believe that the future can be predicted that there is a meaning and reasons behind every moves. No wonder therefore that economics, who has tried to explain market movements with theories that gave only a partial explanation of market behaviours with pseudo scientific theories earned the nickname of the dismal science, echoing Mark Twain's famous quote: “ there are three kinds of lies: lies, damn lies and statistics”.

Markets are moved by e-motions not statistics. Emotions are what stick in our memory and attract actions. While every investment decision starts with an idea, we believe that to be actionable, the idea must have some emotional power. This emotional power is the power of story telling.

As Stalin once noted: „One death might be tragedy, but a million deaths is a statistics“. 

Clearly, you do not move the crowd with statistics, but you can change the world with a good story. 

The same is true for stocks. There are tens of thousands of stocks and stories to chose from and attention spans are short. Yet, the market will concentrate on a few. Stock markets‘ performance follows the 80/20 rule, whereby 20% of stocks may explain 80% of the market behaviour. For the active portfolio manager, this has important implications as the portfolio must concentrate on those stories that will be in demand and have that extra something that will command the premium whenever we will need to sell it. Stocks are sold. And nothing sells better than a good story.

A stock is indeed more than a simple mathematical net present value function of statistical attributes, the same way a luxury handbag is not just a leather bag, but the result of a long history: what designers would call the brand DNA.

In his excellent book “Start with Why”, best selling author and management consultant guru Simon Sinek discusses two essential processes of information diffusion. As financial markets’ price discovery mechanisms are an information diffusion/digestion process, it’s worth paying attention to how people apprehend information and the knowledge gets diffused.

Sinek’s core argument is that story telling is the key to success in business. Every great business starts with the core question of why. The same is true for a great equity story. It is not the what that matters most, but the why.

Nothing is more powerful to captivate the imagination of the crowd than a good story. It is intoxicating and contagious. Every bubble found its roots in a great story. Think of the internet bubble. At the beginning, it was a new promising media, but the power of the story was such that it captured investors’ imagination and changed the world for good. All the great stocks I owned had a great story to tell/sell and possessed the emotional appeal that grabbed the heart and the imagination of the crowd. 

Finding great ideas starts with the story board. Such stories must have a certain coherence, a certain harmonics. The text can change, but the context responds to a certain cyclical rhythm, the one that gathers momentum and moves crescendo up to a certain climax when all the plot gets revealed for everyone to say yes of course.There is nothing new under the sun and it pays to study the classics. This time is different are the four most expensive words. 

There are essentially four types of stories. Man vs Man, Man vs Himself, Man vs Nature or Man vs the Supernatural. It’s the conflict that makes the story interesting, the same way it’s the battles that make the story captivating. Moreover, there are always more than one sides to the story. All stories are based on tensions/battles/conflicts and gradual dissemination of clues and facts that help solve the puzzle eventually after a climax.

The law of information diffusion chart below is also useful tool. Whether you are marketing a fund or you are looking at stock prices, this shows that new ideas take time to diffuse. The majority herd and therefore contrarian/new ideas do take time to percolate. Early adopters may get it faster than the majority but the adoption of a story can take years if not decades before it becomes accepted as a new reality.

Stories are manipulative before being cognitive.

We must be careful not to fall victim of good story tellers. The narrative fallacy is how our brain works. Every word and opinions should be looked as a prejudice and every story as “Weapons of mass distraction”. It is important to distrust theorisers, opinion makers and prognosticators. Never accept quickly packaged explanations and be ready to accept randomness and luck/bad luck as a valid reason. For stories to work, they have to a foot in reality and foot in a greater future.

As an investor, the only thing that matters is the probable futures and their respective values. Each piece of the puzzle adds a clue that increases the chances of such and such scenario. The paradox here is that „You cannot connect the dot by looking forward, you can only look backward“. Therefore, by writing the story, you are effectively writing a scenario with many paths possible. As new information gets priced immediately, what is known is worthless. The key therefore is to know what is unknown in that story and get a sense of how the crowd will react emotionally when they will discover the truth, through nuendos,hints, clues etc.

This is the creative part of investing, where there are many answers to the same questions, where investing becomes a social act and is no longer ruled not by the laws of laws of supply and demand but by the liberal arts.

Writing the equity story helps selecting the right stock and even predict the future. It helps structure one’s thought process and put numbers in a historic context. The best stories must be simple and reliable and have that zest of newness.

As a value investor I look to purchase stocks at wholesale price and sell at retail price. I look for bargains, but never forget that I will eventually need to resell at a profit. In brief, I always try to review my portfolio like a shopkeeper would like at its shelves. We buy and sell stocks according to what investors may want to buy or sell in the future. When we construct a portfolio, we always think of our stocks as goods that we will eventually have to be sold. Of course, it is not just how much you paid that matters, but how much you will be able to sell it at.

Recognising what makes a great story is key to become a good investor. In fact, all of my heroes are not just great readers but also great story tellers in their own right, as if the power of stories had given them the gift to write their own story.