The history of financial markets is a history of convincing stories that ended up in disappointment, says Tim Price.
Students of literature call it “the willing suspension of disbelief”. Credit for the phrase goes to the poet Samuel Taylor Coleridge, who proposed that if even the most fantastic story contained elements of human interest and a semblance of truth, readers would turn a blind eye to its more unbelievable components. We are, in other words, suckers for a good story.
Why we love a good story
The primacy of stories in human culture probably has roots deep in our evolutionary history. In an age before writing, our ancestors might have told stories to help each other learn about the threats they faced and pass knowledge down the generations. We may therefore be genetically preconditioned to appreciate a good story – those who could and learnt the appropriate morals survived to tell the story again.
This might be a problem when it comes to making rational decisions. In a rational world, we would gather evidence, evaluate it, and then weigh it before reaching a decision. But as the behavioural economist James Montier makes clear, we are simply not that rational. Economists, when building their models, presuppose that humans act as Homo economicus – as Spock-like automatons that stride purposefully through life weighing up all the facts with a perfect grasp of logic.
But in real life, we’re just not like that. We collect evidence in a somewhat haphazard manner, suffering from all kinds of biases as we do so. Then we construct a story to explain what we have. The story – not the original evidence – is then the thing we use to make a decision, what psychologists call “explanation-based decision-making”.
The chances are that you have suffered losses in the past by being overly eager to believe a story. We all have – it’s an investor’s rite of passage. The internet bubble provided a perfect example.
The story was that a highly interactive new medium and form of information exchange threatened to steamroller all industries in its path. That view wasn’t necessarily wholly wrong, but it was somewhat premature back in 2000, when online pet-food sellers and fashion retailers could raise billions of dollars in the primary market just on the basis of this compelling story.
Doomsday is here
I began my career in the City in the bond market, which is an oasis of calm rationality compared with the world of stocks, which is overflowing with silver-tongued chancers with dubious and deceptive fables to tell to all who will listen. Or at least that used to be the case. But as the bond markets have swelled, and as quantitative easing (QE) has stretched its tentacles into every market, bond investors have fallen victim to a good story, too.
The most recent plausible but ultimately specious narrative goes something like this. Deflation is taking hold. The (Western) world has gone ex-growth. But fret not, the European Central Bank (or insert your own preferred central bank here) has our back. It will do whatever it takes to ensure that our economy doesn’t repeat the decades-long torture suffered by Japan. It will keep the economy on an even keel by purchasing eurozone debt until doomsday. Doomsday, however, may have arrived.
Over the course of the last three weeks, longer-dated German government bonds have fallen in price, from peak to trough, by a third. A 33% decline in price, practically overnight, is a pretty rum outcome from an asset class widely perceived to be riskless (another intriguing, though not necessarily accurate story). Bond investors bought the story, but somebody else has clearly been selling the bonds.
The return of the nifty fifty?
The history of financial markets is a history of convincing stories. The 1970s gave us the “nifty fifty”: world-beating consumer franchises – the likes of Coca-Cola and Gillette – that were safe at any price. Well, safe until they collapsed. The 1990s gave us what turned out to be dotbombs. The years prior to 2000 gave us global pharmaceuticals (which subsequently derated horribly). The run-up to 2007 gave us global financials (and we know what happened next).
The most plausible story today is an echo from history – the global mega-cap consumer brand. In a world of zero interest rates, meaningful yields from the likes of Nestlé and Roche seem to offer impregnable propects for income and growth at a time when government bonds are clearly an accident waiting to happen (or already happening in some cases).
But Warren Buffett warns us that it is difficult to buy what is popular and do well. Global consumer mega-cap stocks are hideously expensive today, whether expressed in price/book or price/earnings terms. The narrative is now too good to be true.
• Tim Price is director of investment at PFP Wealth Management. He writes The Price Report newsletter with Doug Pritchard.
Category: Market updates