The World 'Twixt Ought To and Is
August 18, 2019·9 comments
Investors and economists have built sophisticated models to explain market movements, yet these same experts watch in real-time as markets behave in ways their models cannot account for. The gap between what theory predicts and what actually happens keeps widening, yet rather than questioning the models themselves, professionals add layers of complexity to defend them. What happens when the intellectual architecture built to guide trillions of dollars in decisions proves fundamentally disconnected from how prices actually get set?
• Sophisticated models fail to predict daily market movements, yet their defenders invent retroactive explanations to preserve them. When markets move on a tariff delay that should have minimal economic impact, the response isn't to question the model but to adjust what it measures, claiming the move was about something else entirely.
• The problem isn't that models sometimes miss. It's that professionals respond to failure by making them more elaborate and specific. Adding variables, finding new time horizons, adjusting parameters until you get an acceptable result becomes indistinguishable from religious justifications for why dinosaur bones exist or why only eight-year-olds face divine punishment.
• Every active investor faces an uncomfortable truth: there is a phantom layer between what they believe should drive prices and what actually does. That layer is made of assumptions about what other investors care about, what information they respond to, and when. Nobody fully understands it.
• Even strategies that worked historically may not work going forward, yet the incentive structure pushes professionals to claim they do. Backtests, simulations, and historical results all pass through layers of partial correlation that erode their actual explanatory power, a loss that rarely gets honestly discussed when fees are at stake.
• The only observable force that might bridge this gap is narrative: what everyone wishes everyone else to believe about why prices move. Financial media, flawed as it is, offers the one world where you can map what actually matters to the marginal price-setter in real time.
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Comments
Hi Rusty
“we reject the learned helplessness of the long now” – absolutely! Except perhaps right now we are invested in preserving our society, not in the capital markets….
Why choose?
"Why do we study common knowledge – narratives? Because we think that studying, identifying and measuring the existence and effects of narratives can be a force for concretion of our investment theses. Can broader adoption of narrative analysis techniques, in fact, deliver on the promise of concretion? Can we better understand how, when and why different facts and events will matter to the marginal market participant in the price-setting process?
I don’t know. I think so. Our historical examinations of the question have produced promising results, but I fear that I am still an agnostic nihilist at heart."
Nice.
I feel like that - an agnostic nihilist - when my portfolio stands athwart current price action for too many days in a row. But even then - my work-in-progress, ET-inspired Clear-Eyes, Full-Heart outlook is making those days less common.
As always, outstanding piece with a lot to absorb, which will require rereading and studying.
Thanks, Mark!
The media narrative may be about trade spats and tweets as causal to August’s market moves. When I look at primary flows: US domestic market ETFs & mutual funds, I can find no fuel for upside gaps, I can find fuel for weak closes. Redemption pressure. When I look at daily trading using a 5 minute tick I find fuel for gaps. The gaps are largely at the open and are likely futures/options driven. Would love to post the chart. Futures driven markets are big capital markets. Us muppets should stand aside while the geniuses blow themselves up. We can’t take the other side of the trade.
Rusty…great piece, great writing, and to quote Arnie in Total Recall…"The best mind F$%K ever!
Street preacher at Penn… you aren’t referring to “Brother Stephen” are you?!! He had a rather harsh collapse if I am not mistaken…
Oh my, no! Different guys. The self-styled Brother Stephen was absolutely of the God-hates-such-and-such placard variety. I think he got arrested for something lewd during my time there, actually.
Thanks, Peter!
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