Republished courtesy of the National Post
by Tom Bradley

In a marketing class during my undergrad, the professor put two words on the board — attitude and behavior — and asked us to draw an arrow between them. Virtually everyone, including me, had it pointing from attitude to behavior. It seemed obvious, but our prof proceeded to show us why we were wrong. Experiences and behaviour shape attitudes, not the other way around.

I was reminded of that class recently when I saw another professor speak on a related topic. Robert Shiller of Yale University, one of the leading economic thinkers of our time, told the audience that his current research is on how narratives influence economic and market behaviour.

I believe he was referring to well worn storylines such as “the world is running out of (or is awash with) oil” or “China’s demand for commodities is insatiable (or peaking).” Narratives that spread like epidemics, whether they’re true or not.

A U-turn

A lot of established trends reversed in the fourth quarter of 2018. At least the narratives around them changed. Just a few months ago, the FAANG stocks were unstoppable but now their growth prospects and competitive positions are being questioned.

At this time last year, we were experiencing broad-based economic growth. Now there are concerns about the length of the cycle and flare-ups in the trade wars. China and Europe are showing signs of slowing down.

The market now reflects what investors perceive the new reality to be around these and other factors. The interesting thing about changing narratives, however, is that often the underlying facts haven’t changed. The issue or concern has just been out of the spotlight.

News but not new

Indeed, some of the current hot buttons are not new. They just have a new headline and a few additional data points.

Debt — Economic growth over the past two decades has been juiced by increased borrowing. The expanded use of, or should I say dependence on, government and private debt has been an unrelenting trend. There’s nothing new here, but investors have woken up to the fact that debt levels are extreme.

China — There’s always a market narrative about China. It’s usually about growth. What’s less often highlighted is how trade relationships are tilted in China’s favour. The western world buys Chinese-made goods in size, but the door into their economy is barely open. Companies that do get in find that government policy can turn on a dime and their intellectual property is not protected. With Mr. Trump in the White House, these issues have taken centre stage.

Human rights — In the western world, we do business with countries, including China, whose ethics run counter to ours. We overlook corruption, how women and minorities are treated, limitations on free speech and political interference in the justice system. These are deeply problematic, yet only figure into investors’ risk equation after a tragic event occurs, like a journalist being jailed or killed.

Lurking in the Shadows

While the negative narratives have been winning the day in recent months, we shouldn’t forget some positive ones that have been shunted to the shadows.

Growing Middle Class — One of the world’s biggest economic forces is the expanding middle class in Asia. This trend is uneven from year to year and country to country but isn’t going away.

Consolidation — Most industries today have fewer, more dominant players, which has a positive impact on profits.

Liquidity — The trillion dollars sitting with private equity managers (plus $3-4 trillion of associated debt) is searching for something to buy. A good portion will go to buying public companies at premium prices.

What’s important

If we did my professor’s exercise using “stock market” and “dominant narrative,” which way would the arrow go?

Like my class, you might think that markets move with changes in narrative, but I’m inclined to think the opposite it true. In the short term, markets rise and fall for a myriad of reasons. It’s human nature, however, to look for a specific cause. The explanations are rarely the cause although some turn into what Professor Shiller calls a narrative. At that point, they can certainly reinforce a trend.

The challenge for investors is to wade through the wave of information, discarding the invalid and unimportant, and not losing track of the powerful and enduring.