This post is opinion only. See full disclaimer below.
What exactly is the deeper secret of stock market crashes? There’s a lot of dimensions to the investing markets, some obvious and others much more hidden. Lots of things going on at the same time. Lots of investing styles. Lots of different areas of the market and goals of specific investors. But what I want to do here is to give you just one key slice of this gigantic space; it’s a very different view than you might often hear, and it’s a hypothesis more than simply a limited momentary conclusion. Don’t think it’s less important because I present it this way: It’s actually a hundred times more important than some super simple account. To borrow the terminology of the philosopher Karl Popper, who was a key teacher of the famous trader George Soros, you can’t prove this hypothesis only disprove it. That’s the case with some of the most important theories in all the higher level theoretical fields. So if you find it interesting look around and try to disprove it, and the truth is, I believe, it will be very, even crucially, true in some ways sometimes. When it’s true, it matters incredible amounts. I know in a blog like this I’m supposed to keep it simple and not ever qualify my statements, but this is not a typical blog. If you want absolute certainty about obvious news, you can find that in lots of other places.
Having said that though, what we are after here is a key deeper dynamic of the investing markets that ultimately leads to stock crashes, the Hegelian contradiction, the thesis-antithesis that causes certain very important market events to occur, the Platonic essence, the yin and yang. Such a deeper conceptual account is a cautionary tale, a little bit like the Greek or Shakespearean tragedies or Melville’s classic Moby Dick. This account is too extreme to apply everywhere, but there are times when the risk of market crashes increases significantly and when what I describe here is the most important thing you can know about the markets, when it becomes practically everything. It’s like revolution. Most of the time society goes along for incredibly long periods on placid seas. But then suddenly there’s a revolution and a typhoon hits. It’s like that with this hypothesis and stock market crashes. By the way, to really understand how this works you’re going to have to work a little harder than usual at understanding a post on a blog. But if you do it and make it to the end of this note, it’s worth it so take the challenge and stick with it.
The hypothesis is that there are two key groups in the stock market and overall investing markets in general that play a very important part in what occurs at inflection points such as market crashes. The first group I will call the political narrative group. Now you’re probably scratching your head at this point and asking what is he talking about, political, I thought this was about markets and crashes, but bear with me, it’s important. These are the people in the markets who tell the retail investors and the public, the customers if you will, but also the participants, a story about the markets. I call it narrative group because it’s about a story that can get people to buy or sell stocks, but mostly just buy. Because there is a goal to the narrative and it concerns in key ways power, which is to say the control and organization of the markets not simply money, we call it political narrative not just narrative. However, all narrative is in some sense inherently political to a degree, but since not everyone realizes that we have to put that in the label for these groups.
These political narrative groups and there are many of them in the markets are constantly coming up with stories about the markets. None of these stories are disinterested, they all are about power. You shouldn’t think that the key players here are a bunch of accountants, econometricians or numbers crunchers. Obviously, valuation is important with financial instruments and many of these people can, so to speak, do the math. But many are horrible at math, and Warren Buffett, excepted, most of the public doesn’t sit around reading financial reports either. Even Buffet who did do this and liked it, added a concept of good will as “intangibles of lasting value,” which is a cultural concept to his investing and actually includes things like narrative. No, the political narrative groups are about power and culture, they create a story, and they are all over the place including the media, of course, which plays a crucial role.
Now, some of these people, when they create their stories, emphasize truth more, and others couldn’t care less about the truth and are more predatory, truth be damned. It’s a little like the difference Plato describes between philosophers and rhetoricians. The former value the truth, the latter only value power. Some of the best investors and traders fit actually in the former category believe it or not; one thinks, e.g. right away of Howard Marks and Mark Spitznagel, but there are many others. To the extent these investors value the truth, they are playing a different game than I describe here, so know that.
The point though with the political narrative group is that they are a key to the investing markets. At the end of the day for better and for worse, the investing market sells people the dream of stock riches, and it does it through one of the most political of all things: a ruling narrative. This political narrative occurs with individual stock picks all the time, but this is much more than that. This is the big leagues. It’s intended to move the emotions of 100s of millions of investors, not some guy at the other end of a cold call sales pitch. There are lots of political narratives being thrown around for the markets, but most of them are short lived. But in some cases a particular political narrative starts to win out. Maybe it’s the Nifty Fifty or maybe it’s the Dot.com Bubble or the BRICS or the Housing Bubble, maybe it’s AI today. The narrative can’t be completely false or no one will believe it, but it can be more or less illusory. This is the moment everyone’s been waiting for. Once this narrative gathers speed, it starts to have a life of its own. It starts to have, to use a term from George Soros in a somewhat different way than he probably intended, reflexivity. Lots of people, many not talented at all at understanding the market, know or think this is their big moment. Even if they’re terrible at what they do, at least for a while they can ride that wave. Others get on board the narrative from a fear of missing out, FOMO, as it’s known on the street. It becomes a key to fitting in at cocktail parties and the group. And eventually as the proverbial story goes, you end up hearing the narrative even at the lowest level of the class system and from people who ordinarily would never buy a stock. I believe it was the famous investor Bernard Baruch, who has a college named after him in NYC, who in a different era said he knew it was time to sell when the shoe shine boy told him to buy stocks. I’ve never liked that story much because the gullible are found equally in every class. Also because, I once knew someone who was shining shoes in a train station and attending a famous film school at the same time and probably ended up making it big in Hollywood, and the great investor Bruce Kovner used to drive a cab in NYC, but you get the point. Everybody jumps on board the narrative.
There is a problem though with this ruling narrative. As I suggested, political narratives in general sometimes have much more truth than other times, and sometimes they are incredibly illusory and predatory. But while many narratives can be the case in the markets and last a long long time usually for a narrative to get to the extent we just described given the nature of group psychology, the narrative has to have a lot of illusion and ideology and predatoriness in it to get that much momentum. If it’s more truthful, it will suggest its own flaws and limitations, it will not be all neat and simple, it will not call forth the most extreme emotions in people, it will be more difficult to understand. There are important exceptions where beneath the public narrative is a deeper truthfulness hidden away that saves the day, but this is hardly ever the case. Usually, by the time a political narrative gets this dominant in the market, it is mostly being led by the rhetoricians not people who value truth a lot or even just a little bit. Those people who still value truth are usually the ones early on trying to warn the public not entice them. Those contrarian voices though get overwhelmed by the millennial dream chasers unleashed by the political narrative.
However, I don’t think we should be too hard on the political narrative makers. There’s certainly plenty to rightly criticize in all this, but the world runs quite a bit on illusion, catharsis, and opiates, and the public seems to really want this kind of narrative. In fact, without at least to some degree this ruling illusory political narrative major parts of the market wouldn’t work at all.
There is however a problem on Wall Street with all of this, and the political narrative never continues for very long in the ultimate scheme of things. People always in the midst of the narrative act like the world will never be the same again and the narrative will go on forever, but those in the know, are always aware the political ruling narratives time is limited.
When the narrative collapses and the bubble breaks, there are lots of explanations. How the narrative wasn’t really accurate or truthful will be explained away in a hundred ways that miss the point that it was created to do exactly what it did. Now, the obvious descriptive explanation is eventually the price comes down to earth because the supply of new buyers starts to run out, and that can be explained in terms of flows of capital and the like in quite sophisticated ways. A more interesting response is that given enough time it would have been worked out, there could have been an extended period when the narrative slowly developed to a more realistic form. The mortgage backed securities given time would have worked out. The BRICS given time would have all had successful economies, the Dot.coms could have worked if all that leveraged debt hadn’t been due. Of course, this misses the point because the whole nature of the initial political narrative was to get the market to go way ahead of itself, and the political narrative was never intended to go on forever. Sooner or later its illusory nature guarantees that.
The best explanation is Robert Shiller’s irrational exuberance theory. Shiller even includes in his account the idea of narrative and media amplification. However, Shiller’s big mistake is he ignores how purposeful the whole creation and amplification of the political narrative is and how much it’s about power. He makes it as if the retail investors just got a bunch of misguided ideas somehow and then these ideas escalated too far. He doesn’t really consider enough how the political narrative was stoked to an incredible degree on purpose not by the misguided crowd but by the powerful and how intentional was the actual process and result. Then again, if he had done all that he might have been too contentious and not have won a Nobel Prize. Nor does he discuss enough the role of another key group we will turn to now in the actual collapse.
Overall after the bubble bursts, it’s entertaining to watch people who understand how this all works, pretend they were as surprised as everyone else, and who could have known better?
So eventually, every illusory political narrative crashes in the market, but the specific concrete cause of the crash is that there is another key group in this process that makes it as inevitable as the sun coming up in the morning or the moon coming out a night. This second group is the antithesis to the thesis, the yang to the yin. This second key group I’m going to call here descriptively the hardcore traders. They get their money a very different way than the narrative group.
Now, I want to be clear that a great many traders do not fit into this category. They do all kinds of things for lots of different reasons. Anyway, the hardcore traders I’m describing here’s main thing is to figure out where the most money is and take that money. They’re sort of like the bank robbers who when asked why they robbed banks said because that’s where all the money is. Now some of those hardcore traders are skimmers. They make their money by jumping the line and taking a little from the next person, who then wants what they just bought but now has to pay more for the item. There are huge groups of quant traders dedicated to doing this, but that’s still overall lower level. Then, among the hardcore traders there are the sharks. I once knew of a trader who always wore a shark’s tooth necklace. Sharks simply look for whatever fish is hurt, whatever stock or investment is having trouble, the bigger the better, swarm that fish and kill it figuratively speaking. But those aren’t the big traders either usually, with some exceptions. All these hardcore traders including the big traders share a common perspective though, which is that the market is a zero sum game. Actually, that’s not exactly accurate, but its how they view things. And you really can’t blame them, the markets are a pretty rough neighborhood and not pretend. In the trading world if I win, someone else on the other side of the trade has to lose and vice versa. So the big time hardcore traders, whales if you want to call them that, or whatever, they look around constantly and say where is the most money in zero sum land we can take and plunder. They’re like pirates looking for the big ship full of gold and the symbolism of pirate stuff is often prized a lot by this group.
Now, what do you think these hardcore big time traders do when they see a political narrative developing. Do you think most of them like some of the truth tellers and seekers steer clear and bide their time? Do they put in long term position trades and wait maybe a very long time indeed for the truth to be revealed? No, in most cases they jump on board and even push the process further many times using lots and lots of extreme leverage. They want to be on the winning side of the trade, and that side for quite a while as more and more investors get pulled into the political narrative dominating the market, is with the narrative not against it.
And now from a long and winding tale, we get to the key moment that matters. For quite a while even sometimes the hardcore traders can go with the wave of the ruling political narrative. The party goes on and the big traders don’t want to ruin it for everyone including themselves. Plus, the bank while the political narrative is in full swing is impregnable like Fort Knox. People like, even demand their illusions, and quite a few hardcore traders could be and have been wiped out trying to be on the other side of the huge wave created by the political narrative. And even more, they certainly do not want to rob the bank while the depositors are still putting lots of money in, there’s no sense in that. They wait. But there comes a time when the bank is more or less filled up. The political narrative has gotten as much money as it can.
All of a sudden more and more of the big hardcore traders notice just how much money is in the bank and increasingly that’s awfully tempting to a bank robber in a zero sum game. As this happens, the other big traders start to get antsy. They have to decide when to jump ship so to speak and keep those accumulated deposits and then go short the market. Some of the less reflective traders won’t even know what’s going on but a lot do. If there are a few truth seekers in the group, they got out in some cases, although not all, a long time ago as the narrative grew more and more unreal, and they’re simply waiting for the inevitable. If they didn’t get out much earlier certainly they do at this point. They aren’t playing this game of chicken. But the hardcore traders often wait too long–in their view it’s a zero sum game after all and they don’t want to get out too soon and lose even for a little while to someone else. It can be kind of fun to watch the big hardcore traders try to figure out how long they can play musical chairs with each other. This is also the time when more and more objections start being heard about the reigning political narrative. However, whenever this occurs most of the time market figures come out and explain those objections away. The illusion holds on for a while.
You need to know also that during this period the retail investors are often piling into the stock bubble while many of the professionals are getting out of their positions. Many of the whales who understand how this game is played and hold very large positions in a narrative they themselves have largely created need the naive amateur, everyday investors to dump those shares on and get out of the bubble in time and they do just that. It’s very hard and costly to get out of big positions in a crashing market when everyone is selling after all .
But at some point it’s time to be on the other side of the trade and the big money hardcore traders come out and let everyone know in no uncertain terms that there is no Santa Claus. Often it’s some major event that inevitably in the way that it occurs simply makes the political narrative too difficult to maintain in the face of reality. This is after all not a novel, there is still a whole other world of real valuations and a real economy and lots of other parts of the market outside this game. Perhaps important companies have bad earnings reports or a key economic indicator suggests the bubble can’t be maintained. Sometimes, this all occurs and nothing really changed that much at all except the prices start to fall and don’t come back. Buy the dip is no longer taken seriously . This is the point when the political narrative is overthrown and the crash occurs. It’s a pretty messed up period to say the least, a little like a revolution in society. Lots of money is lost and Wall Street lays off workers. Even the broader economy can be badly effected.
But just know that when that occurs someone’ is still on the other side of that trade. Some of the hardcore traders definitely shorted the illusion at the right time and made off like bandits. Many of the big money whales dumped their shares on the retail investors before the crash occurred. Quite a few traders also jumping ship at the right time, got to keep a lot of that capital added by the political narrative in the latter stages before the value evaporated. Is it wrong for the hardcore traders to ultimately tear down the illusory political narrative? In some ways sure it’s predatory, but the market is a rough place and there are no guarantees, and the game is what it is and has been for an awfully long time and is unlikely to ever change. The key is that you understand how this works.
If you want to avoid all this, don’t get caught up in a political narrative that becomes extreme, be a contrarian and go your own way even if you have one less cool thing to talk to your friends about. If you do want to play, get out early while the party is still on an upswing. But even the hardcore traders actually perform a certain important service in that they’re basically forcing the market back to a reality principle. Markets are supposed to reflect reality and properly price risk and have that truth about them. Nonetheless, this moment when the illusion gives way to reality can be extreme indeed. Obviously the political narrative should have been explained a lot more fully. Though one expects that human nature being what it is, no one really would have listened anyway. The millennial dream is way too appealing.
When everything is done crashing, three groups emerge back on the scene. They, too, may be said to be on the other side of the trade. The value investors get to buy stocks for super low valuations from Mr. Market in the way Warren Buffet describes and to provide much needed capital to keep the markets functioning. The contrarians, who never believe in the group’s illusions in the first place, are buyers here, the whales start buying also, and many of the the hardcore traders provide liquidity knowing now that the crash has occurred that the trade is heavily on the long side and switching sides once again.
There’s a lyric in a Clash song that goes, “I ain’t given away no secrets, right?” I think I’ll end this post with that.
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