At The Money: How to Use Narrative Information

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0:54Investors have long been taught that fundamentals drive stock prices. Revenue, growth, profits, as Benjamin Graham taught us, in the short run, the market is a voting machine, but in the long run, it's a weighing machine. But what if it isn't? What if narratives are driving market valuations? I'm Barry Rittles, and on today's edition of At The Money, we're going to discuss how to identify when market narratives overtake fundamentals. To help us unpack all of this and what it means for your portfolio, let's bring in Ben Hunt of Persean. Ben's firm studies narratives and the stories that shape markets, investing, and social behavior through the lens of information theory.

1:44So Ben, let's start with a definition. How do you define a narrative in the context of markets and investing? It's a simple definition. A narrative is an answer to the question, why? why did the market go up today? Why should you buy this stock? Why should you sell this stock? Why should you vote for this person? Any answer to the question why is a narrative. Well, how do you distinguish between something like data, which arguably comes with a storyline attached to it, and just a straight up, hey, Bitcoin is millennium or digital gold? How do How do you define the difference between this? I guess this stock is cheap with a PE of nine is a narrative.

2:35Yeah. Well, why is a PE of nine cheap, right? Or why is a PE of three cheap or 15 cheap? These are all stories, Barry. Any valuation, any multiple, any meaning that you attach to numbers, it's a story. It's an answer to the question, why? Why do I call it cheap? Why do I think you should buy it? Why is this interesting? Those are all why questions. And the answer, those are all narratives. So how do you identify any particular narrative that may be driving a particular stock or asset class or the overall market? What tools do you use to help discern that? Well, let me start by saying what I don't care about.

3:25So what I don't care about is truth or accuracy. I mean, it sounds crazy, but I... Not at all, because you're trying to figure out what the crowd believes, whether it's true or not. Well, if it affects their behavior, it matters. It matters, right? So I've given up on trying to figure out what reality is. What I'm trying to figure out is how is reality being presented? How is it being presented to us? So what I'm looking for are elements of presentation. I'm looking for word choice. I'm looking for how loud is it being presented to you, how frequently it's being presented to you. But most of all, Barry, I'm looking for a concept that you talk about in network math, and it's called density.

4:17and I'm looking for how the language is connected to other words. In fact, those are the measurements you use in network math. Those are where we talk about betweenness. We talk about connectedness and centrality. Those are the measurements because I'm looking at the presentation, not at the reality. So how do you measure density? You hinted at some of it, how loud it is, how repetitive it is. How do you tell when a specific narrative is beginning to exert influence over prices? Yeah. So Bob Schiller wrote a pretty good book a couple of years back called Narrative Economics. And the takeaway from that book is that you should think about and understand narratives in exactly the same way you think about and you understand disease.

5:13I mean, you use the same measurements. You remember when we were talking about COVID, it was R0, right? How fast does it spread? How quickly does it spread? What is the medium in which you can spread most easily? It's exactly the same thing here, Barry. It's exactly the same thing. We're really using exactly the same math as you would use to try to understand epidemiology and the spread of a virus. So what we're looking at, though, instead of the atmosphere or wastewater, we're looking at the words. We're looking at all the words that are out there in terms of text of what's being written, what's being said.

6:00This is all unstructured data, and we're looking for the presence of certain ideas, clusters of words that spread through that medium of media in exactly the same way that a virus spreads through the air or through the water. If you're a financial advisor or you're a market person of any sort and somebody comes up to say, yeah, why the market go up today? And you could say, well, there are a hundred different reasons, but basically it was just variance. you know it's just it's just it's just random walk it's just a random walk by it went up today so someone will hate that answer by people hate that answer because it's a crappy story right it's a it's a it's a story true but it's not compelling exactly it's not truthy right it doesn't it doesn't connect with you it's like well that's disappointing i want a story so So the stories that are basically there to fill the time, and these are typically examples where I call them descriptive narratives.

7:12They're answering the question why, but they're describing why something happened. Always after the fact, never in advance. Always after the fact. That's exactly right, Barry. So what you'll find is that, I don't know, it's earnings season, and who comes out first with earnings? Financials, right? And so, you know, Citi and Goldman Sachs, whoever, they'll report some good earnings. The stocks will go up. And afterwards, Kramer and everyone else has got to tell you why. And they'll say, oh, I'm bullish on financials, and they'll give you a reason. and that the half-life for that sort of narrative it's a week or two right i mean it's it and and what you want to do with that honestly barry is you want to fade it right you you you want to look for that to appear in your bloomberg email in the morning saying oh market experts bullish on financials because blah, blah, blah.

8:18And when that drum beating gets pretty loud, when it's appearing in your morning email, I want to fade it. You don't want to press it. You want to fade it because this is just the ordinary business of Wall Street. You've got to have an answer to why. It's almost usually just variants or some combination of idiosyncratic stuff, but you've got to come up with some blanket why. And if that gets a lot of play, I want to go the other way. Now, there's another type of narrative, though, where I want to press it. And so that's what we call prescriptive narratives. It's not saying, oh, the Fed is dovish.

9:00It's saying, you know, Mohammed El-Aryan will come out or, I don't know, Trump will come out and say the Fed should be dovish. You see the difference? It's not describing what's already happened. It's trying to lay the framework for what should happen. So let's delve into that. What sort of tools are you using to identify these narratives, be they descriptive or prescriptive? How much lead time do you get to analyze this giant corpus of noise and commentary and data that is produced every single day? Well, this is what good traders, honestly, and investors have always done. uh they've they've always made these sort of um assessments of the news and the stories that are happening so this what we're trying to do is we're trying to externalize what good traders and i'll call it short-term investors have always done they've always internalized this so anybody can do this you start looking for the words that are trying to prescribe versus describe that'll you you can you can pick this up in whatever you do what we're able to do though today as because there's now big data as because there's big compute is we can read everything i mean humans we're all limited in what we can read what we can pay attention to in our little corner of the world what's possible today is to read everything and to analyze exactly this sort of word choice.

10:48So what sort of output do you get from your big compute that's scraping everything, sifting through all the language? Does it identify specific words? Does it identify themes? I'm assuming artificial intelligence and big data analytics is a key part of this. What does the output look like to you? Well, let me start with where it starts. Because it's not that the output comes from what you put into it and what you want to put into it. And this has to be human generated are, well, what are the ideas? What are the narratives that I care about? Here's why that's important, Barry, because let's say you're a value investor, you've got a vision, and you've got a view on a stock.

11:37And like all value investors, you think the market has not recognized the story about this stock that I think is really important. So what you're looking for is not how loud is that story right now? That story is dormant. You're looking for that story to start being told. So you can't start this from asking AI, Hey, AI, what are the prominent stories right now? Because it can only tell you what's being spread right then and there. What I find the way to really make money with narratives is to say, what narrative is dormant today? I want to see when it starts to get discovered. It's that discovery phase when the market, quote unquote, wakes up to a story that you've been looking for the market to wake up to.

12:37That's how I find you can most reliably make money from narrative investing. So I get the sense we're still in the early days of narrative investing as a key strategy, at least in terms of using AI and big data. What do you see developing in this space? What's the narrative about narrative investing?

13:06very this is like i say this is an old idea it's if you if you go back and kind of look at your wall street history or if you talk to kind of traders today what they're always looking at is the news that comes along and they're trying to say hey do i fade that you know is that story worn out? Is it topping over? Or does this story have legs? Is this the start of its spread like a virus? So it's an old idea. What's possible today is to quantify it. What's possible today is to externalize what good traders have internalized in the past. So it's not that it's, you know, inventing cold fusion or really doing anything that's new in the world.

13:58What it is able to do, though, is to make that sort of analysis, to look at not what reality is, but how reality is being presented, and make it available over a much wider scope, not over just that little area that the good trader really knows a lot about, and make it available over a lot more publications and things that are being written. because humans can't read everything. Really, I think it's a way of, I hate to call it, democratizing investing. I really hate that idea. But it really is a notion of creating a new instrument so every investor can understand, well, what are the stories that are being told about the world today?

14:44So to wrap up, technology has enabled us to read much more than we were capable of reading as individuals. In fact, the machines can read everything and we can use those machines to identify dormant narratives that might lead to increases in either a particular stock or asset class or market. Fair statement? Very fair. What you're looking for is what's new, What's changed? Because when the narrative changes, that changes behavior. Fascinating stuff. I'm Barry Ritholtz. This is Bloomberg's At The Money.