As someone who comes from a data driven background one of the things that has always intrigued me about financial markets is that despite being a wellspring of raw data it is driven by narratives. Humans do seem to prefer stories over data – in effect we are a hairless ape that prefers stories to data. In many ways this is understandable since our ancestors only possessed an oral tradition. We had no means of capturing and analysing data until relatively recently. There is some evidence of “scientific” or “rational” thinking data back to 1600BC but these are one offs – the natural world was still explained by superstitious narrative. The scientific method in its modern form only dates back to the 19th century.
Part of the primacy of the narrative is that it offers explanations for things that may be either too hard to understand or simply unexplainable by those reporting on them. The financial media is full of what I would call the narrative fallacy, that is people making post hoc rationalisations for things they do not understand. In part this lack of understanding stems from a failure to understand the context in which data is being received. For example this morning the ANZ bank reported what has been interpreted as a stagnant profit result.
ANZ has reported first quarter profits unchanged from last year, in part due to an increase in loan loss provisions.
The bank posted an unaudited first quarter statutory profit of $1.65 billion, unchanged on the same period last year.
Its preferred cash profit measure, which excludes certain one-offs, edged only slightly higher from $1.73 billion to $1.79 billion.
Both figures were substantially lower than the bank’s most recent $2.23 billion fourth quarter statutory profit, and its $1.93 billion cash profit.
In response, ANZ shares had dropped 2.5 per cent to $34.99 by 11:22am (AEDT).
By way of contrast, Westpac and NAB were both 0.5 per cent higher, while CBA was down 2.7 per cent to $90.96, but a large part of its fall was due to trading without rights to its latest $1.98 interim dividend from today onwards.
The implication of this narrative is that ANZ has done poorly today whereas other banks have done well. This poor result is therefore due to what the market considers a mediocre result. Implied within this is that ANZ represents a poor investment than its cousins. If I tracked the relative performance of the banks in the morning session this would seem to confirm this perspective. It would seem as if data and narrative are in alignment.
However, what is lacking is context – the data needs to be seen within the framework of the longer term. If we look at relative performance for the past five years a different narrative emerges.
ANZ is now the second best performing of the domestic big four banks. The narrative has been altered by the data. However, there is another element to this that needs to be touched on. Too often the narrative seeks to explain something that needs no explanation. Markets are simply dynamic nature systems, as such they obey normal laws of distribution. My expectation would be that the prices of something such as ANZ would have a natural movement pattern a little bit like the ebb and flow of a tide. The Average True Range of ANZ at present is $0.55 – on any given day my expectation would be that ANZ might move by a proportion of this defined movement. In part some of the movement today could be explained by reference to its standard distribution of prices. This, however, would make for boring reading. You could hardly have a news item that said XYZ share went down today and this was expected as defined by the structure of its volatility. Truthful but boring and definitely lacking in the emotional engagement we seek from narratives.