‘Narrative Confusion’ Is New Only If You Shun History

In recent days, we have seen a rather novel twist on the this time is different mentality that often surges during stock market corrections (sharp, sentiment-fueled drops of -10% to -20%): the claim that investors have to deal with a multitude of competing market-related narratives, and that this is somehow new. One Wall Street Journal piece positing this called it “narrative uncertainty.”^[i] Supposedly until now, stocks have had only one big story at a time—making the conflux of Ukraine, oil prices, inflation, rate hikes and China’s latest regional lockdown a perplexing conundrum.^[ii] Competing, colliding narratives, the story goes, mean heightened volatility and struggling stocks. And, well, we agree shifting headlines are probably contributing to stocks’ yo-yoing this week—that is par for the course during corrections, when emotions run hot. But take a trip with us down memory lane, and you will see this time isn’t different—there are rarely periods in which investors have only one narrative to grapple with.

For instance, consider 2013. The eurozone was still in recession when that year began, with headlines shrieking over possible defaults of sovereign nations like Italy leading to the euro currency’s splintering. That was also the year the US and UK briefly flirted with intervening in Syria’s civil war and the Fed signaled its plans to taper quantitative easing bond purchases (QE). Cyprus endured its banking crisis and bailout, terrorists bombed the Boston Marathon, and the US had a government shutdown and a pretty hyperbolic debt ceiling standoff. That is a heck of a lot of narrative uncertainty! Yet global stocks topped 25% that year, and the S&P 500 topped 30%.^[iii]

Or, how about 2012? That was the year Greece defaulted twice, terrorists struck America’s Libyan embassy, MERS erupted and the Fed felt compelled to roll out a third round of quantitative easing—such was sentiment about the allegedly weak US economy still needing life support. There was also a contentious US presidential election, which came amid frequent handwringing over the expiration of Bush tax cuts and automated “sequester” spending cuts—a frightful combination none other than then-Fed head Ben Bernanke dubbed a “fiscal cliff.” The UK was flirting with a double-dip recession, the eurozone was still contracting, and Japan was struggling to find economic momentum. Pundits now portray this as a year when Fed bond purchases made stocks an easy, one-way decision, but we have receipts! We tracked developments on these very pages throughout! Sentiment was the polar opposite at the time, and stocks endured a correction that spring. Yet even with that volatility and a drumbeat of bad news on the economic and geopolitical fronts, global stocks delivered 15.8% and the S&P 500 rose 16.0%.^[iv]

A look back at 2009, 2010, 2016, 2017 and 2019 would show similarly nice returns flying in the face of everything from North Korean intercontinental ballistic missile tests to new tariffs to even more contentious elections as bad news and strong economic fundamentals continued playing what might have looked like a game of tug of war. Yes, there were some not-so-great headline-filled years, like 2015—a year when the S&P 500 was only slightly positive, with a correction in the year’s second half paring returns. That year, we had Vladimir Putin bringing Russia’s military into Syria’s civil war. A popping stock market bubble in China and a shock devaluation of the yuan. A Greek election that brought a self-described radical leftist party into power—followed by rejected bailout terms, a national referendum that almost took the country out of the euro, and the country’s third default of its debt crisis. Oh, and that December we had the Fed’s first rate hike of the 2009 – 2020 bull market—and the start of the ECB’s quantitative easing program, sparking fears of divergent monetary policy. But the issue for stocks wasn’t that headlines were tugging markets in different directions. Indeed, stocks rose nicely through the events in Greece and in the wake of Russia’s formal intervention in Syria. The year’s negativity concentrated in a short, painful burst when China shifted its currency policy—everything else was just part of the backdrop wall of worry.

Which is the point. It is a human compulsion to focus on narratives. But markets don’t think like that—they are a lot colder and, over more meaningful stretches of time, a lot more rational. Headlines can jar sentiment and stock prices in the short run. But beyond that—say, over the next 3 – 30 months—stocks do an excellent job of filtering out the static and focusing on what actually matters to expected earnings. That includes relevant political and economic drivers. There will always be competing variables—some negative, some positive. But the market’s collective wisdom efficiently assigns probabilities to both the good and bad and discounts their impact. The sum total of that good and bad, in general—and how it relates to expectations—is what ultimately pushes stocks higher in a bull market and lower in a bear market.

Counterintuitively, we think it is bullish that pundits’ biggest instinct right now seems to be to throw up their hands in pessimistic confusion—that is a classic correction reaction. The big story or stories can easily blind people to history and what actually matters to stocks. That is what enables sentiment to overshoot and tee up the rebound that follows. So don’t fall for the umm … narrative … of narrative confusion. Just remember that eventually, stocks shift from being a voting machine to a weighing machine, and even with today’s bad news, there are plenty of drivers in place to propel earnings growth for stocks to weigh.