Narratives are all around us – none more so than the equity market in which I am but one of many participants. Narratives or as many of the synonyms above like- tales, stories, portrayals etc etc can be very entertaining and powerful things. One of the first things I try to look at when looking at markets is – “whats the narrative?”.
We use narratives in the equity markets because its much easier than going into detail on the given topic, if I were to blog about the many different factors making up not just the domestic equity markets but also the global equity markets then I fear I would have to include many pictures of sideboob or some salacious headlines littered through this post just to keep your attention – a la Daily mail style.
What is much easier is narratives. What I am interested in, is when narratives start to intermingle, change or stop dead in their tracks. For examples of this its easier to just stick the US equity markets, after politics probably one of the biggest circuses in town- laden with narratives.
Just in the last few years we have had some of the following narratives:
- Monetary policy is inflating the stock market
- The FED will step in whenever it gets ugly
- Low oil prices will provide a boost to the consumer and bump in inflation
- Rebounding oil prices will cause a drag on the consumer and deflation
- Structural investment will make America Great again
- Donald Trump will bring back manufacturing jobs to America
- Tax reform will be a boost to stock market
- Trumpflation, Trump Bump, Trump Trade
All these sentences have been uttered to describe why the equity markets have been going up over the last few years, but whats most interesting is the eternal optimism of equity markets – especially in the US.
One of the most powerful narratives since the GFC has been QE, monetary policy and the FED all combining to provide protection on the downside and squeezing asset prices higher to stoke inflation. My bet is that if you asked most equity participants to write down the mechanics of structurally how QE was operated and how that actually translated into a squeeze in equity markets you would be met with a lot of blank paper. However that was the dominant narrative and the engagement of this narrative ranged from those who downright accepted that in theory it worked, those who grudgingly accepted the policy and did not want to “fight the fed” and there were those who just got carried out fighting the narrative altogether.
Whats very interesting is that despite QE ending over two and half years ago the narrative prevailed long after. The FED tapered and eventually simply stopped outright purchases and some time later even eased themselves into a tightening cycle. How frightening – we needed a new narrative, and bloody quickly. If you look at the price action in 2016 this is what a “narrative-less” market looks like. Completely sideways, basically there was nothing to excite in either direction.
As I argued in the following blog post What has monetary policy done for you lately? we needed to convert from a state of monetary policy holding up equity markets to fiscal policy. (See below excerpt from said post)
And boy did we transition sharply. No sooner was it confirmed that the supposedly populist candidate Donald Trump was to be the next President of America so too did equity markets quite literally buy into the “hype”, “narrative”, “tale”, “story”. Quite literally by the open of the equity market the next day equity prices were rising and rising quick smart. Small cap equities – a proxy for the “rise of the middle class” under President Trump rose an astonishing 22% straight through till End of November and for now is still maintaining those highs.
The narrative is pretty clear –
Through a combination of tax reform, infrastructure investment, immigration control and most importantly regulation reform Donald Trump will make America great again and unleash growth that has been held down for years.
Now another rule I like to follow in equity markets is that the markets just dont give a damn what you think. You can slap your forehead and give me all kinds of economic theories as to why Donald Trump will not achieve anything, first of all most of this is to do with your own biases. Most people I know dont like DT. Its a fact that the majority of voters didn’t actually like him in that he lost the popular vote. Your opinion on DT quite literally has nothing to do with anything. What matters is will he do what he says he wants to do – and then will it work ??
Equity markets so far have traded the narrative – the big question is have they bought the narrative, i.e. how long are they willing to be commited to this narrative before things start to come unstuck. The market is long equities – how long they are is anyone’s guess and it often ranges between styles etc.
One of the more popular styles out there is Risk parity- I am no genius on this strategy but I think its safe to say that with the increase in bond volatility relative to historic norms and the massive slump in equity volatility relative to historic norms this is a potent combination for those managers following RP to be turbo long equities and not too bothered re bonds, if I were a risk manager at a certain Connecticut based risk parity led hedge-fund with gods money under management I would be feeling extremely uncomfortable at the moment at definitely out of my comfort zone.
What could cause this narrative to become unstuck. Like I say – I would prefer to align myself with the narrative BUT be prepared or wary of triggers that can unhinge it or indeed re-enforce it. Narratives need maintenance after all. What triggers am I looking at/for?
- We already have evidence that its not going to be cake walk for DT. His relationship with Paul Ryan the speaker of the house and Republican seems to be strained. It could well be fast becoming a reality of that old cliche of an “outsider” who is trying to change things is going to experience a lot of frustration. I think DT got his first taste of ” how we do things around here” last week when he tried to rush through amendments to the ACA and his own party halted him in his tracks – despite spending the last 8 years railing against Obamacare.
- Then we start hearing quotes from same Paul Ryan suggesting that obviously they are open to tax reform but it may take considerable time. Well of course it will take time to implement this – unfortunately that’s not what markets want to hear – we bought equities in November and now we need another oomph to get this thing moving again or we will look elsewhere.
- The theme that DT tends to act hastily, off the cuff, without thought has always been an overhang – from his late night tweets to his sometimes off comments in a presser. So far this has only emboldened him and seemed to make him more appealing to his die hard supporters, everyone loves a “character.”
- I literally know nothing about Geo-politics outside of the headlines- but guess what?- so does about 99% of the population, his latest move to sanction a fistful of rocket launches on Syria in retaliation for a chemical attack by Assad on his own people certainly seemed to me like a hasty act. I will not rule out there may well have been good motive or strategic rationale for doing it, but for sure it seemed out of the blue and hastily arranged. Also see his supposed tweets upon the very same subject : (obviously I am not going to scroll through DT’s timeline for verification of these tweets- so if its “fake news” then ok- Ive been duped )
- Yes a lot of the right are gun toting nuts that like to talk tough, but I also think they bought into the idea of why should Americans be solving international disputes – especially when its unlikely most people could confidently locate Syria on a map if asked on the spot. A lot of Trump’s campaign had a theme of isolationism and putting America first – this resonated with people and I think its something that his support will give him a pass on this time, but will not tolerate him getting into any kind of protracted war down the road. Sadly he may have already forced himself into one but this remains to be seen. But its a trigger and I will be looking for signs of waning enthusiasm form his core support.
- If his relations with the media take a sudden change for the better it would be a trigger for me too, it probably means something is coming that he needs positive publicity on, it would make me ultra cautious of risks to the upside.
- If the same people that are standing in opposition of him start to make positive noises about tax reform or repatriation of profits to US from corporate’s abroad then again this is a trigger to the upside- a re-affirmation of the narrative if you will.
About this time I usually like to wrap things up by saying something like “to make a long story short” but the whole point of this post is that I have tried to make the short story long. Knowing the buzzwords of the narrative and simply repeating the mantra in your head will not get you anywhere- knowing the narrative and understanding the mechanisms behind it will put you in a much better position to trade the narrative but not get sold on it.