Shifting Narratives

Market narratives appear to drive short-term results—These narratives are elusive though, subtly shifting over time, one step ahead of most investors—Ultimately, market narratives are just noise to long-term investors.

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SHIFTING NARRATIVES

Humans hate uncertainty. We have a strong desire to feel we know what comes next, even at the expense of being prepared for what actually comes next.

This desire is present in market narratives. Headlines must be written daily to explain yesterday’s movements and today’s expectations.

Will we see a soft or hard landing? What is the Fed’s next move? Is inflation tamed or rampant? The answers to these questions will be clear, in hindsight, years after the narratives have passed.

Yet we force the issue today, scrutinizing the data, squinting to see insight that isn’t there.

Macro Narratives

The market's short-term fluctuations are fed by these narratives, reflexively. On a day-to-day basis, investors agree upon the most important message. This message then drives the near-term market fluctuations, creating excitement around mundane data releases.

By stepping back from the daily headlines though, it becomes apparent that these market narratives subtly shift over time, revealing their uselessness. At the start of 2024 the world focused on the US Fed. Investors tracked voting members’ opinions, dissected transcripts, and analyzed the history of interest rate policy.

As we moved into summer the narrative simplified. We were assured that decision making at the Fed was data dependent, so the market focused on the CPI. 

But the CPI narrative was short-lived. Today eyes are on the labor market and unemployment, that second part of the Fed’s dual mandate that was conveniently ignored just months ago.

Just when we know the answer—inflation is down, the Fed will cut, markets will rise—the narrative morphs and slips through our fingers. Market narratives are flimsy and fleeting, offering comfort but never following through.

Changing Crazes

A similar phenomenon can be observed with market crazes. These crazes last longer than macroeconomic narratives, but rarely survive to the “long-term.”

Remember Meme Stocks? It was almost four years ago that Gamestop wreaked havoc on short-sellers. AMC and Hertz followed, capitalizing on retail investor interest to raise billions of dollars of equity. But the narrative is over. The entire theme has been relegated to the past.

Energy transition, a more wholesome theme, saw capital flow freely into the renewable energy markets. Despite long-term tailwinds to the industry, short-term cyclically has won the day.

Today’s craze is obviously artificial intelligence. How much longer will this theme last? We are certainly at the beginning of the technological revolution AI will bring to the world, but there is little correlation between technology revolution and stock market returns. Super Micro Computer, the flimsiest of all AI trades, is already down nearly 80% from its peak in March.

These crazes are short-lived to the long-term investor. Making money on any of these narratives, or at least not losing it all, typically requires exiting before the market moves to a newer, shinier craze.

The Glacial Pace of Value Creation

Long-term investors need to sit in uncertainty and move at the glacial pace of value creation. The market narratives that exist do impact businesses, but not in the way fleeting headlines suggest. We must follow the narratives for years, even after they pass from the public eye.

Inflation

According to the headlines, inflation has been tamed, approaching the Fed’s target of 2% annually. But the economic impact of inflation lives on.

Taming inflation is not the same as preserving profitability for the stock market. Businesses without pricing power will be unable to pass through the next round of inflation to the consumer.

Exiting the Covid crisis, all businesses received a free pass to increase price. With consumers flush with cash and store shelves empty, there was little pushback on broad based price increases. Today this dynamic is reversing. Even if inflation slows, the profitability of the broader stock market is now at risk.

Interest Rates

The Fed is now in cutting mode, the question is how quickly will rates come down. Headlines no longer opine on bank solvency, commercial real estate losses, high-yield debt defaults, or the many listed businesses that have fixed-rate debt maturing in the next few years.

There is too much debt in our financial system and much of it will need to be refinanced at increasing expense.

Recession Fears

To date, the Fed is being praised for not destroying the economy, facilitating a soft-landing for the US. Inflation is down, employment remains robust, and interest rates are declining. It appears the Fed has fulfilled its mandate.

But when do we declare victory? Have we won if a recession arrives next year or in 2026? Can we ever beat the economic cycle?

Ignore The Narratives

Shifting economic trends last for years or decades. Market narratives move on before investment results are in, outpacing the market itself.

Market narratives, for a long-term investor, are pure noise. Worse, they disguise the noise with the appearance of insight. Maybe the ostrich that buried its head in the sand was a long-term investor.