The first article in the How to Read Financial News Redux series discussed how prices drive narratives. That’s because readers want a story, especially if the explanation confirms what they already believe.
The next installment discussed how to understand consensus. Often the consensus is correct and the market narrative reliably explains price action. But I learned early in my career that old narratives cast a long shadow and may obscure the truth.
OPEC and Oil Prices
When it came to oil prices in the 1970s and 1980s, the consensus narrative focused on the Organization of the Petroleum Exporting Countries (OPEC). OPEC controlled oil prices for a long time, and analysts spent countless hours dissecting its every move. And that worked for a while.
But by the 1990s, OPEC’s influence had faded. Only the media hadn’t caught on. So they continued to interpret oil prices through the OPEC prism. Many investors accepted this interpretation and didn’t look any deeper at the oil and energy markets.
That turned out to be a big mistake. Why? Because while OPEC had been the narrative, it was now just the noise. And the conventional wisdom didn’t recognize the shift until it was too late.
A Cautionary Tale from Metallgesellschaft
In the early 1990s, I was a small-cap energy fund manager and global analyst for large-cap energy at Schroders. I studied energy prices, particularly oil futures, refining margins, differentials in prices among energy products, and the earnings mix of the big oil firms — exposure to oil, gas, refining, and chemicals.
In 1993, Metallgesellschaft (MG) took large positions in futures contracts as a hedge. And it all went terribly wrong. By September, MG had bought 160 million barrels of oil swaps and futures. And incurred a $1.5 billion loss in December 1993.
MG’s trading dominated the futures market and this affected oil prices, especially as oil traders got wind of MG’s vulnerability. “As long as its huge position was in the market, MG hung there like a big piñata inviting others to hit it each month,” Ed Krapels wrote in 2001.
Oil prices fell 30% from April 1993 to December 1993 before rebounding 45% by July 1994. The media blamed the volatility on OPEC and changes in demand.
Oil Price Volatility, West Texas Intermediate, 1993–1994
What Did the Media Say?
Eventually, the media reported on the scandal at MG, and Time included it in its 2012 list of “Top 10 Biggest Trading Losses in History.” But most of the financial literature has focused on MG as a cautionary tale about derivatives and risk management.
Not everyone was fooled. As Krapels observed:
“. . . by Sept. 30, 1993, MG’s positions comprised 16% of all the open interest outstanding in the NYMEX oil contracts . . . According to MG, the position it was rolling over in the market each month was so big that it was distorting the normal equilibrium of supply and demand. The company says its massive position was equivalent to 85 days’ worth of the entire output of Kuwait.”
Unfortunately, very few people picked up on the implications of Krapels’s new narrative. To the best of my knowledge, the rest of the financial media stuck with the traditional explanation: Oil price volatility in 1993 and 1994 could be attributed to the usual suspects — OPEC and supply/demand.
Lost in the Sands of Time
Even after the MG revelations came out, the subsequent news coverage failed to incorporate the new information about oil futures into the narrative. Instead, the media fell back on the old misleading OPEC story.
Financial historians have not done much better. You might think that MG would leave clear footprints in the sand and live on as a moral fable with obvious lessons. But you would be wrong — I had to do lots of detective work to find the right explanation. And I already knew what to look for. And like financial news media, most historians still attribute the oil price volatility of 1993–1994 to OPEC.
Why did I understand these events? Because I was managing an energy fund and had access to sell-side analysts, trading rumors, and the usual assortment of unpublished scuttlebutt — information that most investors and the media can’t access, even after the fact.
So I learned that when you don’t understand why prices are moving, it pays to remember a particular aphorism:
“Maybe someone knows something you don’t.”
This has served me well. Especially when the market goes against me. When it’s impossible to separate the narrative from the noise, you might be best served by just liquidating your position.
My Favorite Filters
Some commentators are like noise-canceling headphones. They are original thinkers without hidden agendas and can filter out the static and feedback. I already mentioned Jeff Miller and Brian Gilmartin, CFA, but my two other favorite sources are
- DataTrek: Nicholas Colas and Jessica Rabe distill the essence of market action in densely written daily emails. Their topics range from the hidden market cap of tech, to bitcoin, to Story Time Thursdays. Their writing combines intellectual rigor with actionable ideas, and they offer links to an eclectic range of sources. Rabe worked at my firm and we collaborated on Alts Democratized.
- AQR 2019 Capital Market Assumptions for Major Asset Classes: This source includes commentary on various asset classes and strategies thanks to AQR’s emphasis on alternative investing. AQR’s Research dissects market narratives from a quantitative viewpoint, and the Perspectives from Clifford Asness are exceptionally well written. My favorite Asness piece? “Stock Options and the Lying Liars Who Don’t Want to Expense Them.”
Ask Open-Ended Questions
As you study the consensus and the popular market narratives, you will uncover anomalies. This happened to me last year when I read Mary Meeker’s Internet Trends 2018.
Slide 218 showed the global leaders of the internet. A graphic ranked the top 20 public and private firms by market valuation. Curiously, every single company on the list is domiciled in the United States or China.
Why isn’t there a single company from Brazil, Germany, Israel, Japan, or the United Kingdom? There was no clear answer. Intrigued, I dug deeper into tech and China and developed my own theory.
- Economies of scale and network effects create a winner-take-all environment, so market leaders have huge advantages.
- The globe is splitting into two economic spheres: An Asian one where China is preeminent, and another where the United States is most influential.
Inspired by ideas from DataTrek, I delved deeper and found that China and the United States approach technology and privacy and security in vastly different ways.
I am not a tech analyst, but I believe these divergent approaches will affect technological research and development, especially in facial recognition and other aspects of artificial intelligence (AI). Regardless of how this plays out, the results will have profound impacts on investing, economics, and society.
All because I saw slide 218 and asked, Why?
My investment process and reading habits are designed to be streamlined and give me time to go deep. I conduct open-ended research because I believe it has more value than studying daily news and daily price movements. I do not have an informational advantage in trading, so I expect to be the sucker at the table. As an associate told me a long time ago:
“There are investors who are smarter than you, have better tools than you, and who work harder than you. How will you compete with them?”
This doesn’t mean that you never have an edge — sometimes you do. But this advice taught me to be humble about my investment process and to focus on risk management in my positions and portfolios.
In addition to white papers, I recommend the following:
- The online catalog at your local library: Why search for books on Amazon when your local library will get it for free? My hometown library has online tools to search and request books. Borrowing has two advantages over buying:
- It encourages you to take chances on unknown authors and topics. Maybe you enjoy what you selected or maybe you hate it. But serendipity stimulates your creativity. Personally, I try to read a variety of recent books, just to get a sense of the zeitgeist.
- It imposes a deadline so you don’t wind up with a stack of good intentions. As the deadline looms, you skim the book and learn what you can. And if the book really is good, you renew it.
- Audible: Audio books are great for the car, the treadmill, and other times when you can’t read. I recommend The Great Courses and these two investing-focused lectures:
- Your Deceptive Mind: A Scientific Guide to Critical Thinking Skills, by Steven Novella, discusses logic, perception, and various cognitive biases. I will cover the fourth lecture, “Flaws and Fabrications of Memory,” in the next installment of this series on memory contamination.
- The Fall and Rise of China, by Richard Baum, studies the historical, cultural, and political roots of modern China.
It takes mental energy to tune out distractions and stay focused, and with a baby in the house, I need every trick in the book. I recommend the following:
- Reduce interruptions: I read long-form material early in the morning or at scheduled times during business hours. I go offline, with no phone, email, or text alerts. Just me and my coffee.
- Use an hourglass: You can’t alway unplug for hours on end, so sometimes I use sand timers to keep from zoning out. There’s something about sand running through an hourglass that helps me keep on task and on schedule.
- Use white noise: For times when you can’t eliminate distracting sounds, you can mask it with white noise, a fan, or an air conditioner.
- Wear earmuffs: I prefer earmuffs over earplugs because they’re easier to put on and take off. I have a huge, ugly pair that lets my wife know I’m “under the dome.” They communicate to people that you’re trying to concentrate. (Just don’t abuse the privilege and tune people out all day.)
- Listen to music: Sometimes I wear earmuffs on top of noise-isolating earphones. It’s a great way to improve the sound of cheap headphones. It can also help you focus, though you will be the last one out of the building if a fire alarm goes off. Instrumental music helps me tune out distractions, and inspirational songs help me plow through paperwork, which I hate with a perfect hatred.
On a side note, I’ve noticed that investment paperwork just keeps getting longer and longer. Now that the forms are stored electronically, there’s no limit to how long they might become.
My prediction? By 2030, the paperwork will be so long, our avatars will read it for us and sign on our behalf.
In the fourth and final installment of this series, we’ll look at “memory contamination,” which happens when our recollection of events is corrupted by a mix of truth, half-truths, speculation, and fabrication.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: ©Getty Images/Fuse
Continuing Education for CFA Institute Members
Robert J. Martorana, CFA, has worked on the buy-side since 1985 as a stock analyst, portfolio manager, research director, financial advisor, and editor of a hedge-fund website. In 2009, Martorana founded Right Blend Investing, a fee-based RIA that manages individual portfolios and does consulting for the asset management industry. RBI has one unique claim to fame in that it supports an orphanage in Andhra Pradesh, India.
Since 2011, Martorana has published over 1,000 pages of contract research, and he is co-author of Alts Democratized by Wiley Finance.