Mailbag: Wall of Worry

Can you please explain what you mean by wall of worry? ie, fake or imagined hurdles?

– @MonirTheKu

Climbing a wall of worry is the least understood and most powerful crowd behavior of a bull market. The phrase refers to investors bidding up stocks when news comes out that some worrisome issue for markets has – huzzah! – been successfully overcome. Then tomorrow there’s another worrisome issue that all the talking heads are buzzing about, but soon enough – huzzah! – there’s a resolution to that problem, too, and markets take another leg up. Wash, rinse, repeat. If you haven’t noticed this time and time and time again over the course of the past few years in this long-in-the-tooth-but-still-chugging-along bull market, then you’re just not paying attention.

But there’s nothing fake or imagined about the problems for the market. They’re all quite real. But they’re also manageable. They’re imminently solvable, if not in fact then in narrative. Meaning that there are darn few cans than can’t be kicked down the road with a pleasantly framed press release. For example, is tearing up NAFTA a real problem for markets? Yes. Is today’s “much better than NAFTA” agreement between the US and Mexico a solution for that problem? Please. In classic DJT style, it’s like trading in the family minivan for a motorcycle and telling your wife what a great deal you got and how this is really the perfect way to take the kids to school. But that doesn’t mean the announcement isn’t good for another leg up in markets and another record close. I mean, you could’ve traded the minivan in for three magic beans. At least we have a vehicle here. Huzzah!

More generally, climbing a wall of worry is – like all market behaviors – a great example of Information Theory in action, which is why I started this note with a picture of Claude Shannon, the Bell Labs scientist who invented the field, or at least the modern version of it.

Here’s the central insight of Shannon’s work: information is measured by how much it changes your mind. That’s it. There is no Truth with a capital T to information. Information is neither true nor false. It’s just more or less influential. If a signal doesn’t make you see the world differently, then it has zero information. As a corollary, the more confident you are in a certain view of the world, the more new information is required to make you have a different view of the world and the less new information is required to confirm your initial view. As a result, the informational strength of any signal is relative. In fact, the same signal may make a big difference in my view of the world but a tiny difference in yours, in which case the exact same message has a lot of information to me and very little to you.

The hallmark of a market climbing a wall of worry is that the “worries” are not widely held. They’re not Common Knowledge. They’re stories that are presented to us as worries, as in “here’s what experts think might derail this market.” As a result, it takes very little informational strength to change your opinion about the worry and decide that it’s actually not a worry at all. In more technical terms, the informational hurdle for a new and higher equilibrium view of markets is relatively low. Repeat this a couple of times, and you have a market that is “climbing a wall of worry.”

I wrote a lot about Information Theory in the early days of Epsilon Theory, including ways to represent its dynamics graphically, and it’s going to be a focus going forward. If you’d like to read more, and you’re curious what diagrams like shown below have to say about lots of investing behaviors, but especially technical analysis, take a look at “Through the Looking Glass” and “Sometimes a Cigar Is Just a Cigar“. Oldies but goodies!