[Ed. note: I’m often asked what authors have influenced me, or who they can read to get another perspective on narrative in markets. Top of the list should be Chancellor Palpatine George Soros, and the first book to read is "The Alchemy of Finance”. So glad to see ET contributor Demonetized rediscovering Soros with this note!
Also, if you want to read an oldie-but-goodie ET piece on all this, check out "The Music of the Spheres and the Alchemy of Finance". It was one of my very first articles, and is also the origin story of my avatar, Claudius Ptolemy.]
I revisited some of George Soros’s writing on reflexivity over the weekend (thanks Ben!). In doing so, I realized my initial reading, years ago, had been extremely superficial. Back then, I focused on feedback loops as amplifying the usual cognitive and emotional biases we point to in investment writing. Things like confirmation bias and loss aversion and overconfidence. This reading of Soros wasn’t necessarily wrong. But it was narrow and incomplete.
When Soros writes about reflexivity, he isn’t just arguing cognitive errors made by market participants cause prices to diverge from the objective reality of the fundamentals in self-reinforcing feedback loops. He’s arguing the fundamentals are often, if not always, themselves subjective realities.
In this 2009 piece published in the FT, for example, Soros wrote:
Feedback loops can be either negative or positive. Negative feedback brings the participants’ views and the actual situation closer together; positive feedback drives them further apart. In other words, a negative feedback process is self-correcting. It can go on forever and if there are no significant changes in external reality, it may eventually lead to an equilibrium where the participants’ views come to correspond to the actual state of affairs. That is what is supposed to happen in financial markets. So equilibrium, which is the central case in economics, turns out to be an extreme case of negative feedback, a limiting case in my conceptual framework.
When you model a stock, or an economy, or a real estate deal, you’re not transcribing objective reality. You’re drawing a cartoon. At best your cartoon will be a reasonable estimate of the probability-weighted present value of the future expected cash flows associated with your investment. But even that’s probably a stretch. Because most of the modeling we do is based on statements or assumptions with embedded reflexivity.
Soros again:
Consider the statement, “it is raining.” That statement is true or false depending on whether it is, in fact, raining. Now consider the statement, “This is a revolutionary moment.” That statement is reflexive, and its truth value depends on the impact it makes.
What Soros is describing here is Narrative–and in particular Common Knowledge. What isn’t made so clear in his writing, at least what I’ve read of it, are the precise mechanisms through which reflexive statements propagate. But it all clicked into place for me during my rereading. To borrow Soros’s framing: the truth value of a reflexive statement is a function of the credibility of the person or institution making it.
In other words, Missionaries drive reflexive processes. Why?
Because making reflexive statements with high truth values is something only Missionaries can do. Only Missionaries have the power to create and shape Common Knowledge
Consider the reflexive statement: “the fundamentals are sound.”
The statement has no truth value whatsoever if I write it on this blog. Not for any reason related to the intrinsic qualities of the fundamentals and their relative soundness or unsoundness, but because my writing on this blog will not have any impact on market prices. Form an Information Theory perspective, this blog contains very little information (if any).
Now, if Jay Powell says “the fundamentals are sound”, that’s an entirely different proposition. Because Jay Powell can do something I can’t. Jay Powell can move the market. Jay Powell can even alter the strategic calculus for his Missionary brethren. Most public statements Jay Powell makes are therefore chock full of information.
If the market accepts the statement “the fundamentals are sound” at face value, it may rise in acknowledgement of the sound fundamentals. On the other hand, the market might take the statement as meaning the Fed will raise interest rates to prevent the economy from overheating, and therefore fall in anticipation of tighter financial conditions. Likewise, the statement “the fundamentals are unsound” can have a positive effect, if market participants interpret it as a signal for looser financial conditions. Sound familiar? We have, after all, been living this subjective reality for the last decade or so.
The information content of Jay Powell’s statements is always high.
The truth value of Jay Powell’s statements varies with their impact.
Missionaries use reflexive statements to create and shape subjective realities for the rest of us.
Fed Watching is the ultimate reflexive sport. If you believe there is some kind of capital-T objective Truth to be found in Fed Watching, I am sorry to be the one to tell you but you are one of the suckers at the table. The Fed knows we all know that everyone knows the information content of Jay Powell’s statements is high. (We call them Fed Days, for god’s sake) The Fed plays the Forward Guidance Game accordingly. Sometimes it uses its “data” and “research.” Sometimes it speaks through one of its other hydra heads. The tools and tactics vary, but they’re all deployed to the same end: to shape the subjective realities of various economic and political actors.
The thrust of Soros’s writing is that all social systems are subject to reflexivity.
In other words: it’s the Missionaries’ world, and the rest of us are just living in it.
Not as public and impactful but I’ve worked in corporate positions for more than a decade and I have seen the same process occur with respect to strategy and performance; changing of metrics to look at; seeing subtle “winds” changing in executive meetings because of what one senior person said or didn’t approve. Even the attendance of a higher executive at a run-of-the-mill operational meeting. I’ve also worked with a smaller brand within a larger context that didn’t manage the narrative about them at all, it had no missionary for a while and very weak and useless one for a while and it was such a super sad situation — as if in the negative feedback loop that Soros discusses; in “reality” this smaller division is insignificant, poor-performing, has no leadership, is a “dud”; it always struck me from the beginning why no one just picked up and changed the narrative, no one changed the metric from revenue to “new customers” or “brand awareness” or “product views” I mean hell pick anything!– it seems easy with a small brand, just manage the higher ups and your teams to look at something else besides the bad sales figures but true you need a Missionary!
So true. It’s a fractal! This is (unsurprisingly) remarkably similar to what goes on in Investment Committee meetings. The decision making process has relatively little to do with the data and EVERYTHING to do with the personalities around the table and the politics of those relationships. Only a Missionary can effectively sponsor an idea. Incidentally, I think it’s kind of silly to put non-Missionaries on these types of committees in the first place. In practical terms their presence is meaningless. You can just wheel them in to run through slide decks as needed. It is interesting to consider, however, that the illusion of control/influence (a kind of theatre) might be essential to keep an organization functioning…
Never believe a rumor until it has been officially denied.