Soros, the new Citizen Kane? (Credits: mindfully.org)
On December 2009, the euro traded at $1.51. Today, it trades at $1.35. What can explain this 11% downfall in little bit more than 2 months? An avid reader of the Wall Street Journal or the Financial Times will eloquently explain that it just reflects the faster recovery of the US economy out of the crisis vs. Europe, amplified by fears that Greece may default on its sovereign debt. End of story? Not so fast. A closer look will reveal the perfect case study for the power of self-fulfilling stories in financial markets.
Deeply ingrained in our collective subconscious is the fear that we are getting manipulated by higher forces. Not so long ago, people questioned the power of mass media and how Rupert Murdoch or Silvio Berlusconi could bend reality with their editorial lines rather than reporting it. I will argue that hedge fund managers and other leading investment bankers have become the new Citizen Kane, shaping reality with powerful storytelling. Financial markets have slowly but surely built a very advanced language that now allow them to communicate and broadcast complex stories. Puts, call, credit-default swaps and other derivatives constitute the building blocks of their vocabulary. Traders have become the journalists that put those words together, following the editorial line dictated by their fund manager. The assets under management, the equivalent of circulation, provide more or less clout to the fund editorial line.
Smart investors like Jim Rogers or George Soros know how to leverage stories to sway the market in a given direction. Of course, they cannot build a story from scratch; they need facts the same way journalists do. However, people overestimate the power of facts and underestimate the craft behind story telling. Soros and co. do not need good stories; they need story that sticks in the market players’ mind and then self-fulfills. This reminds me of a book “Made to Stick” where Cheap and Dan Heath laid down the six attributes that makes an idea stick. Let’s use the shorting of Euro as an example to illustrate them. Simplicity: Soros stripped the idea to the core when he publicly warned that if the European Union does not fix its finances “the euro may fall apart.” Unexpectedness: this story shatters the Euro dominance over the dollar slowly built across recent years. Concreteness: avoid complex math, Greece will default on its debt. Credibility: Soros is credited with predicting the British Pound collapse in 1992 – leading to a $1bn profit according to certain traders. Emotional: emphasize the drama, “even if [the Euro] handles the current crisis, what about the next one?” (Soros in an article he wrote for the Financial Times on February 22nd). Stories: while Soros could have just “written” this story through financial operations using derivatives and let the advanced financial community pick it up and amplify it, he knew he also needed to translate his financial story in plain words and thus reach mainstream investors. What a better way to do so than an op-ed in the Financial Times entitled “The euro will face bigger tests than Greece.”
How powerful are those stories? Judge by yourself. On February 8th, a couple of hedge fund managers got together in a Manhattan private townhouse for an “idea dinner.” According to the Wall Street Journal, during this dinner, one manager shared his story on how Greece will default and create a domino effect. By the week of the dinner, the bets against the fall of the euro had risen to a record 60,000 future contracts – highest since 1999. Three days after the dinner, a new wave of selling pushed the euro below $1.36. While we can argue about causality or correlation, coincidence is to be ruled out. It is also said that the fate of Lehman Brothers was sealed during one of those small gatherings.
Where does that leave us? Hedge funds are thriving in very chaotic environments. In the short-term, we can thus expect one or two financial crisis resembling the one we just faced – maybe this time it will involve sovereign debt or even credit card debt. Yet, we all know that in chaotic kingdoms, kings do not last long. So, I would not be surprised if those funds did not survive those coming crises. One or two major failures like LTCM would trigger a massive withdrawal of the assets under management. This will then mark the end of the financial story-tellers like the decrease in circulation announced the slow decline of the printing press.
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