South China Morning Post
Advertisement
Advertisement
Traders on the New York Stock Exchange on March 10, as stocks try to recover from the massive oil shock plunge the day before. Photo: AP
Opinion
The View
by Richard Harris
The View
by Richard Harris

Coronavirus and markets: Why it pays to understand the viral stories that move prices

  • Economists have long been aware of the power of narratives that try to explain or justify what is happening in financial markets. But now we have the quantitative tools to properly study it and model their economic impact, just as the world is in the grip of a global pandemic
Richard Harris
Richard Harris
Why you can trust SCMP

Stock market history does not repeat itself – but it generally rhymes. I came into the stock markets in 1986 on the back of a huge boom, which soon led to the biggest fall in global stock market history – although I was not entirely to blame.

The 1987 crash was caused by soaring US trade and budget deficits that caused dollar assets to weaken and interest rates to go up – overloading a heady bull market. Does that rhyme in 2020 ears?

It was an age of high inflation and crippling interest rates, so the monthly money supply figures dominated markets. Traders would wait with bated breath for M1, M2 or M3 data but no sooner had the figures come out, the market waited for the next month’s figures. You don’t hear anything about the M’s these days.

In 2020, the central banks have overliquefied the global economy, slashed interest rates to less than zero, and created debt levels that make 1987 look like the austerity of a monk. The S&P 500 has nominally risen 12 times since 1987; making it fragile to President Donald Trump’s trade tantrum, slowing Chinese growth, and almost no European growth.
All it took was a global pandemic and a row between Saudi Arabia and Russia over the oil price to set things off. The next narrative is about which dominoes are ready to topple.

From my earliest days on a trading desk, I was fascinated by how stories moved securities prices. Investors could easily be distracted by relatively minor market narratives if the news arrived at the wrong time. The City of London was hit by an extraordinary storm during the crash of 1987 that closed the market – and traders could not close their books. That alone wiped billions off share values.

Robert Shiller, the Nobel laureate, in his recent book Narrative Economics: How Stories Go Viral and Drive Major Economic Events, likens the spread of stories that explain or justify what is happening to a viral spread – something we now all understand. Economic narratives are contagious and affect economic behaviour – just as the coronavirus has done.

This new study that focuses on the investment and trading aspects of market stories is what I call narrative finance. Narrative finance concerns stories not about what I think, but about what everybody else thinks.

Narrative finance is the voice of behavioural finance, which analyses the psychological biases that drive investment decisions. Behavioural finance has been around for the last quarter of a century but never gained much traction as it cannot be easily quantified for traditional rational investment valuation models.

Narrative finance can, however, take advantage of quantitative techniques that have only been available in the last decade, like rapid counting of stories in global media. We can even analyse the demand for particular narratives from reader clicks. Relationships between narratives can be exposed through network and cluster analysis. Indeed, Shiller’s model of a viral narrative spreading can now be tested using data from a real coronavirus.

Market crashes throw rational financial models aside and narrative takes over. Take a look at the Post’s business section, for example, and see if you agree with the news stories on every page. One narrative cascade is based on the desperate economic damage done by downing tools in China, Europe, and perhaps soon, the United States.
My first column this year was a narrative of the possible trigger factors for a 2020 crash. Naturally, I did not predict a virus – although No 4 was a recession narrative. That was on the cards the day China closed Wuhan. Today’s viral market narrative is about trigger No 1: a liquidity crisis or credit crunch, where there is not enough money available to pay the bills.

Narrative finance is already discussing how the authorities will deal with a looming credit crunch, as the global economy is going to need cash to tide it over. Central banks, unable to usefully cut interest rates, are more likely to print money by buying bonds, aka quantitative easing.

Governments are already musing cutting taxes, paying subsidies, and encouraging banks not to call in loans – all funded by borrowing printed money. The trick will be to ensure that the liquidity goes to the needy and not (as in 2008) to reward moral hazard; those who bet and lost.
The long-term narrative is that huge debts and printed money are going to come back to haunt us. Policymaker reaction in the next few weeks may determine our wealth for the rest of the 2020s.

Narrative finance will be developed to add a premium or discount to rational investment models – but in the next business cycle; it is too early for this. Like every other new model, it will improve nowcasting, thereby helping more accurate forecasting.

More accurate modelling of the real economy, including that of the narratives that make the world go around, will help policymakers and investors make earlier and better decisions.

Richard Harris is chief executive of Port Shelter Investment and is a veteran investment manager, banker, writer and broadcaster, and financial expert witness

This article appeared in the South China Morning Post print edition as: Power of the narrative
Post