“An accumulation of facts is no more science than a pile of bricks is a house.” Henri Poincaré

I never cease to find amusement in this comment by Russell Napier:

“Every morning across the world, at meetings in investment institutions, talk invariably turns to explaining the market movements of the day before. If we can understand what forces moved markets yesterday, there is a greater chance that we can understand what will move them today. Of course, on many occasions nobody really knows what moved markets on any given day.
Indeed we can say that what moves markets in the long run is invariably nothing to do with what investors think moves them on a daily basis.”

A similar idea is picked up by Philip Tetlock & Dan Gardner in Superforcasters:

“This compulsion to explain arises with clocklike regularity every time a stock market closes and a journalist says something like “The Dow rose ninety-five points today on news that…” A quick check will often reveal that the news that supposedly drove the market came out well after the market had risen”.

They propose it would be more rational for them to state that: “The market rose today for any one of a hundred different reasons, or a mix of them, so no one knows.”

Our subconscious mind is constantly trying to create order out of chaos and it can sometimes lead us astray.

But do we really have no idea what moves the markets? The answer is nuanced.

In most cases, it is quite possible for market participants to understand why, since yesterday, prices have gone up or down. Key headlines will correctly be pointed at as the major market movers, and to deny this seems preposterous.

So if we do know why markets went up or down overnight, why can we not add up the days to create a plausible account of what is moving markets longer term?

The answer is that market moves are not binary! We may know why stocks rose, but not why they rose by 0.5% and not 1%. We may know why the dollar depreciated, but not why is was by 0.3% and not 0.9%. And yet while this information may seem less important on any one particular day, over time it is the amplitude of the moves, and not just their direction, which dictates where markets tend to longer term.

And here is the thing. The amplitude of the market’s daily moves cannot be explained by the news that came out over the past 24 hours. The market’s susceptibility to that news is key, and depends on forces that are far deeper and less apparent. Longer term trends act like giant magnets with invisible forces on market prices, providing a direction that is obfuscated by daily volatility.

This sits uncomfortably with those who see markets as efficient machines that immediately price in all public information. Because the reality is that in many cases, the market is moving in a direction for reasons that no one has yet identified, let alone rationalised (incidentally, once rationalised, it is priced, and too late to position for).

Demystifying the true longer term market movers requires as much imagination as it does analysis and cannot be induced by only looking at the facts (induction is, in fact, a myth, but that will have to wait for a later post). Plausible causal narratives need be imagined and tested; they can’t be extrapolated from the data. This is why there is skill in investment and why humans will remain necessary in the process.

Russell is right that what moves markets in the longer term has nothing to do with what some investors think move them on a daily basis, in so far as they keep appealing to the most recent headline news. The illusion is created by the fact that they understand the direction and fail to recognise that they cannot explain the magnitude, which is what matters in the longer run.

But for those whose gaze shifts from the rear view mirror to the road ahead and who seek to uncover the hidden causal narratives that explain the market’s susceptibilities and vulnerabilities, a better understanding of market drivers is possible.