Truth VS Consensus: How Financial Markets React

Let's start with a recent example. A few months back, the price of oil was over $90. Some investors started saying it could go over $100 before the end of the year. And I agreed with that thinking then. In fact, they said a conflict in the Middle East can be the trigger.

Since then the world has had the Israel versus Hamas crisis and oil prices are down to the low 70s. In fact, the price broke into the 60s this week of writing. How is that possible?

How is it possible to get the trigger that was supposed to send oil prices through the roof, and the price moved significantly in the opposite direction? That is the factor we are talking about today. Never underestimate government intervention.

The Dilemma of Predictions

I watch investors managing billions of dollars come on business TV to explain their strategy and why they think markets are moving (or where it is going). Every time I do this, I am conscious of the fact that they are selling their positions.

Always remember that the financial markets and the world economy are not correlated in the short term. Don't be deceived by what appears to be a correlation. The market just reveals where people decide to put their money. It's basic demand VS supply.

It is possible to get the economic predictions right and get the bets wrong. And I think this trend is going to be more common nowadays.

For example, let's say someone predicts a recession in 2024. That is the economic prediction. And then they buy a lot of bonds because of the narrative that bonds usually do well in recessionary periods. And then, it turns out that there is indeed a recession. But bonds performed woefully. This is not a prediction, just an example.

This is to show you that just because the economic prediction is right doesn't mean the investment made would be right too. There is a lot of decoupling of correlation these days. So, be careful what you listen to.

Truth Variants

What is true? What is false? It is hard to tell in a world of speculation. This is why I am strongly against speculation. If you invest, follow the long economic cycle.

In following the economic cycle, some years will be better than others. And certainly, you will probably not be among the group that makes triple-digit gains in any given year. But you will always be in the green if you avoid unnecessary risks.

In the financial markets, the only true thing is what has happened or what is happening. What is going to happen is never true. It is like a quantum particle, like Schrodinger's cat. Everything is true until it is observed (in the present).

But instantly it becomes irrelevant. The moment we observe it in the present, it becomes old news. So, it becomes useless to base our decisions on what has already happened. How then do people game this? Technology.

They want to be the fastest to jump on a stock that is popping. So, they get the tech that can deliver in the tiniest millisecond to get the first mover advantage. In that world, no one asks why a thing is happening.

I would be a bad stock day trader. This is because I always want to understand why. Good stock traders don't care about why. They only care about what is happening and what is hot. This is why the financial markets don't correlate with anything in the short term.

So, why do investors come out to talk about why markets are moving? Well, the simple answer is to sell their narratives. Everybody is trying to sell their narrative.

This is why there is no truth. Even if someone gets something right, it is not because they want to get it right. They are selling their narratives. And that is not a bad thing. You just need to be aware of the bias.

I am different because I am not actively managing any fund, nor am I actively trading stocks. I just take pleasure in studying these things and educating people. That is the only way to separate the chaff from the hay. But does it matter?

Consensus Driven World

If bond prices are supposed to go down and someone suddenly pours billions of dollars into it, where do the prices go? It goes up. If all economists come out to say, "the bond prices will go down", the guy who pours in billions just made all of that untrue. And that's fair in the financial world.

Sometimes, it doesn't matter if something is true. If enough people with capital believe otherwise, they can sway the market and build momentum in the opposite direction. And the opposite direction can end up winning in the financial markets.

In the financial markets, truth (in the short term) is often the consensus belief of people with enough capital to back their narrative. Over the longer term, there tends to be a correlation with the real economy.

I would estimate that a sizable capital in today's world can prevail over an economic truth for as much as 3 years. And if a central bank is involved (that is, those with the ability to print money), it can easily go for more than a decade, until there is serious political pressure.

So, is consensus all that matters? No. And remember, it is not the number of people that matters, it is the amount of capital behind those people that matters. But don't blindly trust that people are telling the whole truth also. There are hawks looking for what to short-sell.

Sometimes, these talkers know their audience and they are saying exactly what they are saying because they know their audience will act in a certain way to it. They bait reactions.

Conclusion: Truth, Consensus, and Reactions

This is what the game is about. An economic truth is not true in the financial market unless there is a significant capital consensus behind it. Also, people are predictable. People are more predictable than you think.

The moral of the story here is that everything is a narrative until it happens. Two different narratives that seemingly oppose each other can end up to be both true. The only thing you can count on is the long-term economic cycle. Short-term estimates often fail. Always have a long-term view for your investments.

You can be right and still lose money. Short-term guesswork is bad for investing. Play smart.

Stay rich.

P.S. Here is a piece on understanding economic contractions and why they are necessary