Sometimes I feel sorry for traders/investors who need to construct a narrative as part of their investment process. Whilst you are cocooned inside your own delusional story you would never know whether your story is the right one and is the one the market has chosen. As an example consider the year to date moves of various indices from around the world.
As might be expected there are a range of performances but what is interesting to me is that if you look at the US markets in isolation you see something interesting. The Russell 3000 and S&P500 are doing better than the benchmark index. This positive performance seems quite obvious when you drop in the performance of the VIX – the so called fear index.
The VIX has had a somewhat precipitous drop since the beginning of the year. As such the narrative could go volatility (uncertainty) has leaked out of the system therefore investors feel more comfortable with equities. Sounds reasonable, however, there is always someone who will spoil a good story. Consider the chart below is of the ETF GLD and the Dow since the US election in November. GLD tracks the spot price of gold so it serves as a useful proxy.
Throughout November the gap in performance between the Dow and GLD widened – this would fit our existing narrative of the market being more settled therefore there is no need to set in place a hedge via gold. However , this story starts to change as Trumps profound lack of suitability as President becomes obvious and the performance gap narrows. If we shrink the time frame down to YTD only then the Trump idiot premium widens.
All of a sudden we have a wrinkle in our narrative. The original narrative was uncertainty has left the system, investors are happy and buying equities but hang on the performance of gold which is traditionally seen as a hedge instrument is improving. WTF is going on?
This is the issue with narratives they are simply stories designed to make us feel better about our decisions as such they are equal parts post-dictive error, self justification and comfort food. Hence, they are largely meaningless.
If a trader doesn’t run on a narrative, are you saying gut feel is the way to go?
Once upon a time a trader had an opinion about the market …
So you’re saying some people need a narrative as they are uncomfortable with uncertainty. Having some sort of bead on things gives some relief or there wouldn’t be a market for charlatans. Nice point but we can’t argue with the math hey. Let them grow up!