All-weather investing

Seeking consistent positive returns.

Come rain or shine.

Ruffer provides investment management services for institutions, pension funds, charities, financial planners and individual investors.
All-weather investing
Select Location
UK
Europe
Australia
US
Asia
Middle East
Channel Islands
Rest of world
Type of Investor
Individual investors
Institutional
Charity
Family office
Financial planner
Individual investors
Institutional
Charity
Wholesale
Retail
Institutional
Institutional
Institutional
All investors
All investors
London
80 Victoria Street
London SW1E 5JL
Edinburgh
31 Charlotte Square
Edinburgh EH2 4ET
Paris
103 boulevard Haussmann
75008 Paris, France

Thinking in narratives

Why stories matter

Charalee Hoelzl
Investment Manager*

Stories have always influenced human behaviour: our decision-making is often driven more by a good tale than objective facts and data. But stories can defy reality only for so long.

Eventually, people trust the evidence of their own eyes and realise that the emperor’s new clothes are in fact his birthday suit. Such epiphanies can lead to abrupt regime change, which is why we believe investors should be aware of, and challenge, any prevailing market narrative before acting on it.

As social beings, humans are preoccupied with our own and others’ experiences. We think about these experiences in the form of stories, which reach into every part of our lives. Some are entertaining, such as jokes or heroic tales; others, such as theories or plans, are serious. We watch sports to witness stirring stories of victory and defeat. We are constantly bombarded by media stories, interrupted only by companies using narrative techniques to sell their products to us. Even when we sleep, stories appear to us in the form of dreams.

Why this ubiquity? It seems stories are hardwired into the way we make sense of the world. According to the neurological theory of narrative thought, our brains organise everyday sensations and experiences into a meaningful sequence of events, rather than a set of discrete perceptions. Our conception of time is therefore linear: the past influences our interpretation of the present and how it may shape the future. As Nassim Taleb says, narratives help us to make sense of the world so that it appears “less random than it actually is.”1

The power of narratives

Communication scholar Walter Fisher developed the theory of the narrative paradigm: we use stories because they are more persuasive than logical arguments and more memorable than facts.2

Studies have shown that, unlike other information, we process stories the same way we process first-hand experiences. This is because narratives invite us mentally to rehearse the actions within them. When you perform an action, the same regions of the brain are stimulated as when you read about that action.3

But there are other reasons our brains have evolved to think in terms of narratives. One is evolutionary value. The ability to link previous experience to the present (Daniel stumbled into a lion’s den, and now he’s injured) is central to our understanding of causality, which can help us to extrapolate what may reasonably be expected to occur in the future (stumbling into a lion’s den will probably lead to injury). Thus we can avoid or mitigate risks or take advantage of opportunities that are not immediately obvious.

A second reason is that stories allow us to cut through complexity and uncertainty. Today, we consume more information than ever before. The average person processes as much as 34 gigabytes of information a day (the equivalent of over 100,000 words), and this is increasing by 5% each year.4

Because this vast amount of information is costly to obtain, store, manipulate and retrieve, we summarise and simplify it into stories. Whilst simplification can help, oversimplification can have costly consequences, not least in financial markets.

When narratives become contagious

Nobel Laureate Robert Shiller has greatly advanced our understanding of the importance of narratives in economics. The telling of a good story links up various bits of information into a coherent whole and creates a reason to act in certain ways. Stories sway decisions to hire or fire, to buy or sell, to spend or save. These individual choices, writ large, move markets and drive the business cycle.

In finance, behaviour is driven by expectations of future returns, and expectations are often driven by stories, particularly during times of heightened uncertainty. The simpler a story – the more it extends and agrees with our preconceptions – the more persuasive it is. A good story embeds itself in investors’ minds: the narrative becomes the expectation.

Narratives are powerful when enough people come to believe in them. Shiller draws an analogy with epidemics: “The most contagious economic narratives drive boom-and-bust cycles.”5 These narratives are generally oversimplified to the point where they are easily transmissible – and either wrong or at least exaggerated. And “when we believe a compelling story that turns out to be not true, we can end up holding assets worth far less than the story suggested.”6

Narratives are powerful when enough people come to believe in them.

Current narratives driving financial markets

Technology

Some of the most contagious narratives are new, more resistant variants of old ones. For example, the narrative that ‘technology is taking over our lives’ is just the most recent modification of the technological unemployment narrative that has been periodically scaring people since the Industrial Revolution.7 The fear has always been of chronic unemployment as machines take people’s jobs and produce too much output.

The rise of automation, artificial intelligence (AI) and machine learning have altered the narrative from muscle power being replaced by machines to the wider concern of computers substituting for the human brain. For individuals, this technology narrative creates a growing fear of irrelevance. When transmitted more widely, however, such concerns can affect the broader economy by reducing people’s confidence to consume, invest and engage in entrepreneurship.

Multiple narratives can coexist, reinforcing or undercutting one another. Investors need to assess which will become the dominant narrative driving behaviour and ultimately markets. For example, the technology story is reinforced by the secular stagnation narrative. This theorises that growth and inflation will remain low indefinitely, because developed economies are plagued by an increasing propensity to save and a declining wish to invest. The narrative is powerful because it is grounded in our experience over recent decades.

Set against this is the counternarrative that the same technology could harbinger a ‘fourth industrial revolution’. In this scenario, further technological innovation will support continued strong growth and earnings, thereby justifying higher market valuations.

Multiple narratives can coexist, reinforcing or undercutting one another

Climate policy

For decades, scientists have been warning that greenhouse gas emissions are warming our planet. But, as we have seen, narratives play a decisive role in motivating action, and the climate story was complex and discouraging. For one thing, the message emphasised the costs and burdens of climate policy: there would be “a trade-off between more economic output in the near term and the damage caused by global warming in the long term”.8 In addition, policies to mitigate climate change faced a free-rider problem. Because we all share the earth’s atmosphere, a reduction in global emissions by one country or bloc would benefit everyone more or less equally. In short, “every country has an incentive to let others mitigate, and thereby reap the benefits without incurring the costs”.9 This negative narrative failed to compel action.

Then a counternarrative emerged. Economist Nicholas Stern proclaimed the “transition to a zero-emissions and climate-resilient world provides the greatest economic, business, and commercial opportunity of our time.”10 This new framing – of an optimistic, green transformation story – was based on the pace of technological innovation and disruption, which has substantially reduced the cost of producing renewable energy and storing it in batteries.

Strong narratives can drive market consensus and lead to crowded trades around major themes. Stern’s more upbeat message has not only encouraged people to act on climate change and other sustainability issues, it has also catalysed an ESG (environmental, social and governance) trade in markets. This trade has become prevalent not only because the story behind it is strong – the innovations in sustainable technologies and the promise of higher returns from investing in a better future – but also because the narrative resonates with so many different groups of investors. Whilst it is clearly of benefit that so much capital should flow into tackling climate change and other sustainability challenges, such crowded trades can eventually lead to disappointing financial returns for investors.

Sailing against the prevailing narrative

Stories help investors deal with uncertainty and imperfect knowledge. But contagious narratives which come to dominate can over-inflate expectations – and therefore prices – until a new one challenges and eventually replaces it. The technology and ESG narratives are compelling for several reasons, but they need to be justified by growth in revenues and earnings. The challenge for investors is to be aware of, and to challenge, the prevailing dominant narratives and to watch for any signs of impending regime change.

Ruffer Review 2022
Download our 2022 edition of the Ruffer Review. We explore how turbulence lies ahead for investors as inflation volatility sets up to be the biggest challenge for investors in a generation. We also discuss risk and its repercussions, shifts in global politics and Great Power relations, a warming planet and shifting energy mix as well as financial disruption and regime changes.
Read
The perils of yesterday’s logic
Increasing inflation volatility represents the greatest challenge to investors for a generation. A new regime and the collapse of the financial market status quo requires us to reimagine portfolios. No longer can we rely on yesterday’s logic.
Read
The risk addiction
In the depths of addiction nothing else matters. The pursuit is focused, relentless and uncompromising – dismissive of any potential consequences. So what happens when the addiction is to risk?
Read
  1. Taleb (2007), The Black Swan: The Impact of the Highly Improbable
  2. Fisher (1985), Human Communication as Narration
  3. Speer, Reynolds, Swallow, Zacks (2009), Reading Stories Activates Neural Representations of Visual and Motor Experiences (abstract)
  4. Bohn and Short (2012), Measuring consumer information
  5. Shiller (2019), Narrative Economics: How Stories Go Viral & Drive Major Economic Events
  6. Ritholtz (June 2021), The Big Picture
  7. Shiller (2019), Narrative Economics: How Stories Go Viral & Drive Major Economic Events
  8. Dervis (June 2021), The new climate narrative
  9. Ibid
  10. Stern (2021), G7 leadership for sustainable, resilient and inclusive economic recovery and growth

*Charlee worked at Ruffer until January 2022

This article first appeared in The Ruffer Review 2022

The views expressed in this article are not intended as an offer or solicitation for the purchase or sale of any investment or financial instrument, including interests in any of Ruffer’s funds. The information contained in the article is fact based and does not constitute investment research, investment advice or a personal recommendation, and should not be used as the basis for any investment decision. References to specific securities are included for the purposes of illustration only and should not be construed as a recommendation to buy or sell these securities. This document does not take account of any potential investor’s investment objectives, particular needs or financial situation. This document reflects Ruffer’s opinions at the date of publication only, the opinions are subject to change without notice and Ruffer shall bear no responsibility for the opinions offered. Read the full disclaimer

London
80 Victoria Street
London SW1E 5JL
Edinburgh
31 Charlotte Square
Edinburgh EH2 4ET
Paris
103 boulevard Haussmann
75008 Paris, France