Submitted by Nicholas Colas of Convergex [5] [5]
1,001 Nights Of Stock Market Stories
There is an old Wall Street chestnut that goes, “It’s not a stock market; it’s a market of stocks.” Fair enough, but we’ll take a different approach today to complete this aphorism: “It is a market of stories.” Yes, it is stories that vie for our attention, define our realities, and spur us to action. Recent academic work on the subject reveals that the right narrative – ideally one with a strong human element – physically changes how we process information and make us more likely to empathize with and ultimately believe the stories we hear. Too fluffy a concept for you? The research we cite was partially funded by the U.S. Department of Defense’s Advanced Research Projects Agency (DARPA), and when they have an interest in something, rest assured it has a very serious purpose. As for applications in the world of investing, recognizing powerful stories earlier than the pack is pretty much the job description for analysts and portfolio managers alike. Just be aware that it is all too easy to fall for one as well.
As a child, my parents would tell me stories out of the “1,001 Nights”, a collection of Middle Eastern tales that (in Western form, anyway) include Aladdin’s Lamp, Ali Baba and the Forty Thieves, and Sinbad the Sailor. Only in adulthood did I read the actual translations, which makes HBO’s Game of Thrones look like a 1950s “Archie” comic book. Even the framing of the stories is pretty nasty. At the beginning of the first book we read about a king who, betrayed by his first wife, now chooses a young woman from his kingdom to wed every night. And then early the next morning he has them killed. “It’s not you, it’s me, but follow the man with the ax anyway”…
This goes on until the Vizier’s own daughter, Scheherazade, decides to put an end to the serial killing of the country’s maidens. She marries the king, but on their wedding night asks that her sister might visit for a few hours before the executioner comes at daybreak. The sister asks for a story, and Scheherazade obliges. The climax of the tale comes just as the sun rises, and by this point the King is so involved in the story that he grants Scheherazade a second day of life just to hear its conclusion. The next night she starts a new story, and the same thing happens at daybreak. Fast forward 1,001 nights of stories (2 ¾ years) and the King has fallen love with Scheherazade and they live happily ever after.
If you think this is just old-time storytelling with no place in a modern “Rational” society, consider that the U.S. Department of Defense funds research on how humans process stories through its Defense Advanced Research Projects Agency (DARPA). These are the same folks that brought you highly advanced drone technology, cutting edge night vision systems, micro-sized GPS for people and munitions, and, well, the Internet (original name: ARPANET). Their interest in storytelling is entirely pragmatic, as you can see from this 2011 posting on FedBizOpps (www.fbo.gov [6]):
“DARPA is soliciting innovative research proposals in the areas of (1) quantitative analysis of narratives, (2) understanding the effects narratives have on human psychology and its affiliated neurobiology, and (3) modeling, simulating, and sensing-especially in stand-off modalities-these narrative influences. Proposers to this effort will be expected to revolutionize the study of narratives and narrative influence by advancing narrative analysis and neuroscience so as to create new narrative influence sensors, doubling status quo capacity to forecast narrative influence.” (Translation: Help us understand what stories will cause people to act – especially those stories that we can transmit from a distance – that’s what “Stand-off modalities” means.)
One of the researchers involved in this work is Paul Zak, a Claremont Graduate University professor, researcher, and popular TED conference speaker. In a Harvard Business Review blog posting last week, Dr. Zak outlined his recent research. Here is a quick synopsis with link to the whole post below:
- One important driver of human empathy is a neurochemical called oxytocin, which “Is produced when we are trusted or shown a kindness, and it motivates cooperation with others.”
- With DARPA’s funding, Zak’s team “Developed ways to measure oxytocin release noninvasively at up to one thousand times per second”.
- Through various studies, Professor Zak and his researchers isolated two drivers of oxytocin release in the human brain. The first is attention – people have to shut out all the extraneous noise around them and focus on the story at hand. The second was to have character-driven narratives, namely actual human beings that are relatable to the listeners/viewers. Put those two things together – as Zak does in a 2013 article published by UC-Berkeley about research that focused the story of a young boy dying of cancer – and you get genuine empathy.
- What does empathy get you? Well, crassly put, money is one outcome. In the Berkeley study, subjects volunteered a portion of their honorariums to charity after generating outsized amounts of oxytocin from a heart-wrenching video of a father and dying son. Moreover, in another experiment where some subjects received synthetic oxytocin through the nose, that group contributed 57% more to charity after watching numerous public service ads than the control (no external oxytocin group).
Storytelling clearly matters a lot more than just being entertained or enlightened. An attention-grabbing story about relatable people triggers an actual biological response which, in turn, drives us to action. In thinking through what this means for investors, I arrived at the following list:
- We need people in the mix in order to feel empathy. Wonder why the Federal Reserve does those quarterly press Chairperson press conferences? Communication and information, yes… Without them, however, it is far less likely that anyone will really connect with the story the Fed is trying to tell about the U.S. economy and its policies. Now, if you just don’t like the U.S. central bank, this isn’t going to work on you. Unless to get a hit of that synthetic oxytocin, perhaps. But if you are on the fence, associating a real person with an abstract policy may help. In short, you are more likely to “Buy in” to the policy and story.
- Some investment communities and industry sectors are more prone to “People stories” than others. Every decade or so the venture capital world goes through a meltdown, and part of that failure stems from an overreliance on a particular story. Think “Eyeballs” in 2000. More recently there was a good example of this published on TechCrunch yesterday, outlining the concept of “Fundraising Acceleration”. Apparently venture capitalists are marking up any hyper-growth startup with outsized valuations simply because there are relatively few of them. The idea is that these will be the big winners, so price is less of an issue than access to the equity of such companies. The story here: valuation doesn’t matter – people and narratives do. After all, valuation chatter doesn’t make for much empathy. But a successful serial entrepreneur and a hot new idea sure do. Until, of course, they don’t.
- Use this all to your advantage, and be aware of when you are being gamed. If you are presenting information, realize that the relatable, people focused narrative is your friend if used judiciously. And if you are watching a presentation, remember that you might be the focus of a purposeful manipulation meant to spark the creation of oxytocin and, by biochemical extension, empathy.
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