Enemies Real and Imagined

Today I want to share three things I think I know based on what Radiant, our platform for analyzing the prevalence of various narratives in markets, has been telling us. Then I want to share what I think I think about what that means.

First, what I think I know. And no, I don’t think any of this is particularly earth-shattering or controversial.

I think I know that the prevailing structure of central bank narratives is that the Fed can’t, shouldn’t and won’t move away from a dovish posture.

Within financial news coverage of central bank activities and interest rate markets, our models determined that, after a brief flurry of begging for Fed intervention in early 2020, the dominant archetypal language in central bank coverage for most of 2020 was speculative inflation language. Traditional media outlets, the sell side, the buy side and corporate earnings releases which discussed interest rates at all emphasized uncertainty and speculation about potential inflation that might result from aggressive intervention.

That shifted in late 2020 toward a narrative structure defined less by speculation about inflation and more by speculation about whether hawkish policy would be necessary or whether dovish policy would continue to be feasible. Our judgment was that common knowledge tilted away clearly from fears that banks would be forced to intervene in the direction of “inflation is transitory” in mid-April 2021. In other words, we think there’s a moderate but generally held belief among investors that other investors and the Fed are betting on transitory inflation. More importantly, we think significant missionary effort (i.e. effort to shape common knowledge) is being exerted to maintain this narrative.

Source: Epsilon Theory

I think I know that the most influential language being used to discuss US markets is less convinced that stocks are overvalued, with an emerging pole of those who believe policy and recovery have created pockets of attractive value. These are both features we think create an asymmetric bias toward more constructive / bullish responses to data.

Linguistic patterns consistent with attempts to create a narrative of the market as expensive or overvalued are still at high levels – apparently the “akshually valuations aren’t really historically high, it’s just a shift in market cap to sectors that should be more expensive” mafia haven’t gotten to everyone just yet. The density of these patterns in financial news, research, press releases and transcripts, however, has also been in a period of rapid descent. More importantly, that descent has taken place during period that has almost perfectly overlapped with the transition of the central bank narrative to the dovish “inflation is transitory” variety observed above.

Source: Epsilon Theory

In short, we observe that low-rates-longer-because-inflation-isn’t-really-a-thing stories are demonstrating a pretty strong pro-cyclical relationship with descriptions of how much “value” and “risk” are present in markets. We think, but can’t explicitly prove, despite how inherently sensible it is, that this relationship is causal. That is, we think that what everyone thinks everyone else thinks about dovish Fed policy is shaping how they characterize and describe the valuation and riskiness of their own portfolio positions. Accordingly, we tend to think that continued dovish rates and fed policy remains by far the most important market narrative, and the one most sensitive to change.

I think I know that outside of narratives of recovery, the emerging delta variant does not really represent a significant feature of US equity market narrative structure.

The network graph below presents US equity markets content from news outlets, blogs, press releases, sell side research and transcripts with broad distribution published between June 1 and July 16th – that is, ending just before the more serious attributions of market activity to the delta variant of COVID earlier this week. As usual, each dot/node represents an individual piece of content. Identical colors represent clusters of similar language, as do connecting lines and general proximity on the graph. Up, down, left and right have no meaning other than the “closeness” they otherwise impart. Bold-faced nodes represent those which are about, at least in part, the emerging variant and its risks. Washed out nodes represent those which are not.

In short, there’s a couple clusters off to the distant right of the graph that appear to be principally about these risks. There are some scattered nodes elsewhere. But the graphical representation here is consistent with what the underlying centrality calculations tell us: people are talking about this a little bit, but it isn’t informing or influencing the central discussions of positioning, risk, attractiveness, trade ideas or investment theses.

Source: Quid, Epsilon Theory

So here’s what I think I think:

I think that the primary contributor to the mid-July swoon (or ‘sell-off’ for those who don’t remember what an actual sell-off is) in risk assets was probably jitters about the first premise above. That is, I think most investors fear a hawkish Fed more than the delta variant. More importantly, I think most investors believe that’s what other investors fear.

I think that we reversed practically all of the damage when it became a sort of ‘common knowledge’ that the reason for the swoon was a change in the third premise. In other words, I think that the knee-jerk response by commentators ascribing soft markets to ‘fears about the delta variant’ rapidly built a wall of worry. In our cynical application of the term of art in markets, what we mean by wall of worry is a risk or series of risks that are specifically designed by narrative missionaries to be easily climbed. And once we’ve climbed whatever wall we are being told was what was keeping us back, well…get it? At any rate, because of the underlying narrative structure (or absence thereof) around COVID risks to markets, this would have been a particularly effective wall of worry for getting markets back on track.

What does that mean? I think for the time being that it means that we should expect the delta variant to be the bricks out of which additional walls of worry are built. I also think there’s a point where delta could become the real enemy to the markets, rather than an imaginary one conjured for an easy bounce-back win. After all, a narrative structure that isn’t focusing on something like this at all is inherently a complacent one. And no, I have no idea when or where that inflection point may be.

So whether it’s tradable or not (probably not), following this will still be a good news and research consumption training exercise. For the rest of July into August, keep a close eye on how missionaries describe the causes of any pull-backs. Look for simplistic explanations that don’t seem to match up with the common knowledge of what investors are most concerned about.

Then develop your own heuristics for identifying the construction of walls of worry in the world.

To learn more about Epsilon Theory and be notified when we release new content sign up here. You’ll receive an email every week and your information will never be shared with anyone else.


  1. Interesting. The Fed definitely needs to jawbone markets lower to keep talk about inflation and their impotence to a minimum. Do you think the Fed is conjuring the fake wall of worry to avoid risking crying wolf about being hawkish?

  2. Anyone who has struggled to lose weight knows that the first thing you do is set very realistic, easily achieved goals so you can build momentum at the beginning. Eventually all those little goals, each one surpassed without much suffering, lead to the enormous brick wall that is the basic laws of thermodynamics. That’s when things get hard.

    This market just wants to be up. Most participants are long, and ‘stonks never go down’ is waaaay more fun than taking a beating every single quarter, or month, or week, or hour. Delta provided people with just enough of a “sell-off” to allow more people to BTFD. I predict the next “market rout” comes from renewed mask mandates, likely at the Federal level. That’ll be the excuse for a massive, brutal, gut-wrenching 1.3% drawdown that lasts nine hours.

  3. Good article Rusty, makes the market response this week more understandable.
    Outside the scope of your points in this article but curious what you and others think of the Fed ( and it’s missionaries) risking their apparently strong credibility with the “inflation is transitory” narrative ?

    I.e. if Inflation continues as ugly as it has been does the size of the market fall grow along with the loss of their credibility?

  4. Love this “what we mean by wall of worry is a risk or series of risks that are speciLcally designed by narrative missionaries to be easily climbed.”

  5. Weird that I look at that same quote and get depressed

  6. @chudson : I don’t think it’s really the Fed doing the conjuring, although I’m sure they get how this machinery works.

    @Desperate_Yuppie : I feel seen.

    @psherman : I don’t think they run much risk to their credibility TBH. I think that at some point, inflation WILL slow, and even if we packed five years of Px increases into the interim, they’ll be able to tell a “transitory” story. Hard for me to see what could really back them into a corner they couldn’t cartoon their way out of.

  7. Rusty,

    Until this note, I never thought too hard about the Wall of Worry as I thought I understood it. I get how it works, what I never thought about was that it was intentionally created.

    I assumed it was a “real” thing in that the market had real worries and as those faded or were overcome, the market went up. What stupid me never thought was that the Wall itself was created to be overcome (you can never be too cynical, thank you Lily Tomlin).

    My questions then are who are and how conscious are the missionaries in building the wall? So, for the Delta variant Wall of Worry, did they (news anchors, Wall St. PMs, Washington officials, others?) intentionally talk up the Delta variant as a risk to markets as they knew, eventually, it would look less bad and the market could then climb the Wall?

    As manipulative as this is, you have to hand the missionaries who do this credit for A+ game playing.

  8. Mark, not stupid at all. I think that usage may be the more common, and our interpretation of it simply the more cynical.

    That said, I’m not sure that there’s always an explicit and comprehensive design behind an individual wall of worry. Usually there isn’t. I think it is more accurate to say that there is an explicit and comprehensive structuring of the sell side and financial media that benefits from constantly finding single stories for overdetermined outcomes - then talking them down. That is, the editors push a single explanation, then the talking heads spend days dismantling it and showing that it doesn’t justify that level of “sell-off”, and we end up higher than before. The nature of segments, columns and commentary as they exist necessitate the creation of these walls of worry without any specific intent required, and so they’ve become part of the bullish fuel for markets. I think the DESIGN of sell side and financial news to always find a new axe is absolutely conscious and intentional. Which topic becomes that thing is nearly always less so, at least in my opinion.

    It also makes the role of the missionary even more important. When the right structure for constantly creating these narratives exists, it doesn’t take many influential voices who do have that conscious intent to create common knowledge.

  9. I believe the only way the market gets bearish here, is if covid and the Delta variant goes away. The Fed has “cover” for staying dovish, probably even continuing QE if the virus surges. Market has proven again and again, that the human element means nothing and liquidity trumps everything. I want to be bearish, trying to find a reason for lower multiples, but we’re just not there yet.

  10. News as a service. A loyal servant. A helpful friend.

    “What a large viewer base you have Grandmedia!”

    “The better to tell you with” replied the Wolf.

  11. I actually like your Quid diagram in this article. There are a lot of non-connected groups of nodes, which I interpret as independent thought. Independent thought means (I think I think) less attempt to push a narrative. Yes some are connected but not as great a percentage as many of your other diagrams.

Continue the discussion at the Epsilon Theory Forum


The Latest From Epsilon Theory


This commentary is being provided to you as general information only and should not be taken as investment advice. The opinions expressed in these materials represent the personal views of the author(s). It is not investment research or a research recommendation, as it does not constitute substantive research or analysis. Any action that you take as a result of information contained in this document is ultimately your responsibility. Epsilon Theory will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. Consult your investment advisor before making any investment decisions. It must be noted, that no one can accurately predict the future of the market with certainty or guarantee future investment performance. Past performance is not a guarantee of future results.

Statements in this communication are forward-looking statements. The forward-looking statements and other views expressed herein are as of the date of this publication. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Epsilon Theory disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein. This information is neither an offer to sell nor a solicitation of any offer to buy any securities. This commentary has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Epsilon Theory recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.