Most investors treat narratives as noise. Something emotional. Something irrational. Something to be filtered out so the “real” analysis can begin.
That framing misses the point.
Narratives are not explanations. They are coordination mechanisms. And in markets where thousands of independent actors must make decisions simultaneously with incomplete information, coordination mechanisms determine outcomes as much as fundamentals do.
What a Narrative Actually Does
A narrative is a shared story that compresses complexity into something legible. It tells participants what matters, what doesn’t, where attention should go, and how others are likely to behave.
In complex systems, this matters more than being “right.”
Markets don’t require perfect understanding. They require synchronized behavior. Narratives provide that synchronization.
Consider what happens when a narrative takes hold. It doesn’t just change what people believe—it changes what they think other people believe. That second-order effect is where the real power lies. Once you believe that others believe something, your optimal strategy shifts, even if your own private assessment hasn’t changed.
This is why narratives can move markets even when participants are openly skeptical of them. You don’t have to believe the story is true. You just have to believe that enough other people are acting as if it’s true.
Coordination Beats Accuracy
In theory, markets reward truth. In practice, markets reward alignment.
A flawed narrative that many people act on will move prices more than a correct insight that no one coordinates around.
This is not a moral failure. It is a property of systems with many independent actors and limited shared information.
Think about it from a game-theoretic perspective. If you’re the only person with accurate information, but no one else is acting on it, you’re stuck. You can be right and still lose money. You can be right and still miss opportunities. You can be right and still get margin-called while waiting for the market to agree with you.
Keynes understood this when he noted that markets can stay irrational longer than you can stay solvent. But he was describing something deeper than irrationality. He was describing the gap between individual knowledge and collective action.
Narratives bridge that gap. They create common knowledge—not just information that everyone has, but information that everyone knows everyone else has. That common knowledge enables coordination at scale.
Why Narratives Emerge at All
Narratives exist because information is incomplete, outcomes are probabilistic, and decisions must be made anyway.
You cannot wait for certainty. So systems evolve stories that allow action under uncertainty. These stories reduce cognitive load and enable collective movement.
Humans are pattern-recognition machines. We’re built to extract signal from noise, to find causality in correlation, to build mental models that let us navigate complexity without getting paralyzed by it. Narratives are the natural output of this machinery operating in environments where there’s too much data to process comprehensively and too little time to verify everything.
But narratives aren’t just psychological crutches. They serve a functional purpose in markets. They create focal points—shared reference points that help distributed actors converge on similar interpretations and similar actions without needing to communicate directly.
When a narrative says “inflation is transitory,” it’s not just making a prediction. It’s creating a framework for interpreting incoming data, for deciding what counts as signal versus noise, and for coordinating expectations about how policy will respond.
When that narrative shifts to “inflation is persistent,” the framework changes. The same data points get interpreted differently. The same price movements get attributed to different causes. And most importantly, the range of reasonable responses contracts around a new set of coordinated assumptions.
Narratives Are Not Retail-Only Phenomena
It’s tempting to dismiss narratives as a retail problem. They are not.
Institutions rely on narratives too—they just call them theses, frameworks, mandates, or policy assumptions. The difference is packaging, not function.
Every large pool of capital requires a story to justify positioning and risk.
Pension funds need narratives to explain why they’re allocated 60/40 instead of 70/30. Hedge funds need narratives to explain their bet sizing and their sector tilts. Central banks need narratives to explain why they’re tightening or easing, and when those conditions might reverse.
These institutional narratives are often more sophisticated, more data-backed, and more carefully hedged than their retail equivalents. But they’re still narratives. They’re still simplifications. They’re still coordination mechanisms that allow large organizations to act decisively despite uncertainty.
In fact, institutional narratives might be even more powerful than retail ones, precisely because they coordinate larger pools of capital and because they’re reinforced by organizational incentives, career risk, and fiduciary duties.
If a pension fund has adopted a narrative that equities will deliver 7% real returns over the long term, that narrative shapes not just their allocation today, but their rebalancing rules, their risk budgets, and their willingness to ride out drawdowns. The narrative becomes embedded in the operating procedures. It becomes infrastructure.
How Narratives Actually Move Markets
Narratives influence markets by shaping capital allocation, risk tolerance, time horizons, and acceptable drawdowns.
Once enough actors internalize a narrative, behavior changes. Flows follow. Hedging adjusts. Leverage expands or contracts. Price follows behavior.
Narratives don’t predict outcomes. They constrain the range of plausible actions.
Let’s trace the mechanism more explicitly. A narrative emerges—say, “AI will transform every industry.” Initially, it’s just a story. But as more participants adopt it, observable changes begin:
Capital flows into AI-related equities and private companies. Valuations expand as investors apply higher multiples to revenue and growth. Companies pivot their messaging to emphasize AI capabilities, even if the underlying business hasn’t changed much. More capital raises happen at higher valuations, creating a visible track record that validates the narrative.
Now the feedback loop accelerates. The price appreciation itself becomes evidence that the narrative is correct. New participants enter because they see the momentum. Risk models get updated to reflect the new regime. Hedging strategies shift. Correlations change as everything “AI-related” starts moving together, creating a new factor that didn’t exist before the narrative emerged.
At this point, the narrative is self-reinforcing. It’s not just a story anymore—it’s a structural feature of the market. Portfolios are positioned around it. Risk is managed relative to it. Performance is benchmarked against it.
And here’s the critical part: even if the underlying premise is wrong, the narrative can persist as long as it continues to coordinate behavior effectively. The market doesn’t care about truth in the abstract. It cares about what participants are doing right now, and what they’re likely to do next.
Why Narratives Persist Even When “Wrong”
Narratives are often criticized for surviving contradictory data. That persistence is not stupidity—it’s coordination inertia.
Abandoning a narrative too early is costly. You risk misalignment, you risk underperformance, and you risk career consequences.
As long as the narrative continues to coordinate behavior, it remains functional—even if it is incomplete or partially false.
This is where a lot of rational analysis breaks down. Analysts will point to data that contradicts the prevailing narrative and expect the narrative to collapse. Sometimes it does. But often it doesn’t, and the reason is structural, not psychological.
If you’re managing money—whether for clients, for an institution, or just for yourself—abandoning a narrative that everyone else still believes is a bet against coordination itself. You’re not just betting that the narrative is wrong. You’re betting that everyone else will realize it’s wrong at roughly the same time you do, and will act on that realization in a coordinated way.
That’s a much harder bet to win.
Consider the “soft landing” narrative that often emerges during tightening cycles. The data might suggest recession risk is rising. Leading indicators might be rolling over. But as long as the consensus narrative remains “the Fed can engineer a soft landing,” positioning stays relatively constructive. Credit spreads stay tight. Equity volatility stays suppressed. Flows continue.
You can short this setup, but you’re fighting the coordination mechanism. You’re right in theory, but wrong in practice until enough other participants shift their view. And that shift often doesn’t happen smoothly—it happens all at once, when some exogenous shock breaks the narrative’s ability to coordinate behavior.
Until that moment, the narrative isn’t wrong. It’s just incomplete. And incompleteness is very different from wrongness in systems that depend on coordination.
Narratives vs. Bubbles (The Key Distinction)
Classic bubble thinking assumes narratives create delusion, delusion inflates prices, and reality eventually reasserts itself.
This model works in simple systems. Modern markets are not simple.
Narratives today often emerge after structural forces are already in motion: liquidity regimes, policy constraints, technological shifts, settlement and leverage mechanics.
The narrative does not create the move. It explains it just enough for people to join.
This is a crucial distinction that gets lost in most bubble analysis. The narrative isn’t the cause—it’s the interface.
Think about the housing bubble of the mid-2000s. The popular story is that people believed “housing prices never go down,” and that belief created speculative excess. But that’s backwards. Housing prices were going up because of structural factors: low rates, financial innovation in mortgage products, regulatory changes, and global capital flows seeking yield.
The narrative “housing prices never go down” emerged to explain and justify behavior that was already happening. It made it easier for more people to participate. It reduced the cognitive dissonance of taking on massive leverage. It coordinated expectations in a way that amplified the underlying trend.
But the narrative didn’t create the trend. It accelerated it.
When the narrative finally broke, it wasn’t because people suddenly realized housing prices could go down. It was because the structural supports collapsed—subprime defaults spiked, liquidity dried up, and the mechanical flows reversed. The narrative broke because it could no longer coordinate behavior in the new environment.
This pattern repeats. Narratives are built on top of structural realities. They amplify those realities, extend them, and sometimes help them persist longer than they otherwise would. But they’re not autonomous. They’re dependent on the underlying mechanics continuing to function.
Narratives as Infrastructure, Not Sentiment
Think of narratives like protocols. They don’t tell you what to believe. They tell you how to interact with the system.
When a narrative breaks, it’s usually not because it was “wrong,” but because it stopped coordinating behavior. That’s when volatility appears.
This reframing is important because it changes how you should think about narrative shifts. You shouldn’t be asking “is this narrative true?” You should be asking “is this narrative still coordinating behavior effectively?”
A narrative can be directionally accurate but lose its coordination power if:
The underlying structural conditions change
A competing narrative offers better coordination
The narrative becomes too diffuse to be actionable
External shocks make the narrative’s predictions irrelevant
When one of these things happens, you get a narrative vacuum. There’s a period where the old story no longer works, but a new story hasn’t yet emerged to replace it. This is when markets get choppy, correlations break down, and volatility spikes. It’s not because fundamentals suddenly changed—it’s because the coordination mechanism failed.
Everyone is acting independently, trying to figure out the new rules, and there’s no shared framework to guide collective behavior. This is actually when individual analysis matters most, because there’s temporarily less coordination pulling prices around.
But it never lasts. Markets hate narrative vacuums. A new story will emerge, sometimes quickly, sometimes gradually. And once it takes hold, coordination resumes, volatility compresses, and we’re back to a regime where the narrative shapes behavior more than individual assessment does.
Why “This Has to Work” Is Not Blind Faith
When investors say “this has to work,” they are often pointing at coordination, not destiny.
They’re recognizing that too many incentives are aligned, too much capital is committed, and too many systems depend on continuation.
That doesn’t guarantee success. It does raise the bar for failure.
This is another place where dismissive analysis misses the point. When people say “the Fed has to support markets” or “Big Tech has to keep growing” or “the dollar has to remain the reserve currency,” they’re not making metaphysical claims. They’re observing coordination.
They’re noting that a huge number of actors have positioned themselves on the assumption that X will continue. Those actors have power, resources, and strong incentives to make X continue. They will use that power. They will adapt their strategies. They will lobby for policy support. They will create new mechanisms to sustain the status quo.
None of this makes failure impossible. But it does mean failure requires breaking a coordination equilibrium, not just being “fundamentally wrong.” And breaking coordination equilibria is hard. It usually requires external shocks, regime changes, or the accumulation of stresses that overwhelm the system’s ability to adapt.
Until that breaking point, “this has to work” is not faith—it’s an acknowledgment of how much structural force is aligned behind continuation. And that structural force matters. It shows up in flows, in policy, in market mechanics, and ultimately in prices.
The Intersection with Other Market Forces
Narratives don’t exist in isolation. They interact with the structural forces we’ve discussed in previous articles—price discovery mechanisms, settlement systems, and mechanical flows.
In fact, narratives often emerge to explain or justify what those structural forces are already doing. When dealer hedging is forcing buying, the narrative might be “momentum is strong.” When dark pools are accumulating, the narrative might be “smart money is positioning for a breakout.” When rates are compressing, the narrative might be “the Fed is winning.”
These narratives aren’t wrong, exactly. But they’re downstream. They’re the human-legible layer on top of mechanical processes that would happen regardless of the story we tell about them.
The danger comes when people confuse the narrative for the mechanism. When they think the story is driving the price, rather than the story explaining (or justifying) what the price was going to do anyway based on structural flows.
This confusion leads to bad timing. People short narratives when they should be watching flows. They fade momentum when they should be watching dealer positioning. They call tops based on sentiment when they should be watching liquidity and leverage.
The best investors understand the difference. They use narratives as coordination indicators—signs of where collective attention and capital are flowing—while staying grounded in the structural mechanics that actually determine whether those flows can persist.
When Narratives Fail (And What Comes After)
Narrative failure looks like a loss of coordination. Suddenly, the story that everyone was using to interpret data and guide positioning stops making sense. New information doesn’t fit the framework. Price action contradicts the expected patterns. The story fragments.
This is different from the narrative being “disproven.” Disproof is a logical concept. Narrative failure is a coordination concept. The story doesn’t have to be false—it just has to stop coordinating behavior.
When this happens, you typically see:
Volatility spikes as actors scramble to reposition
Correlation breakdowns as different participants adopt different frameworks
Liquidity gaps as market makers widen spreads in the absence of consensus
Rapid shifts in flows as capital reallocates based on individual rather than collective logic
The recovery process involves narrative formation. Different stories compete for adoption. Early movers test different frameworks. Some gain traction. Eventually, a new consensus emerges—not because it’s more “true” than the alternatives, but because it coordinates behavior more effectively.
This process can take days, weeks, or months depending on how decisively the old narrative failed and how clear the new structural conditions are.
The Takeaway
Narratives are not market lies. They are compression algorithms for collective action.
Ignoring them doesn’t make you more rational—it just makes you blind to how coordination actually happens.
Price discovery tells you where markets move. Settlement tells you whether trades are real. Narratives tell you why everyone is moving together.
And in modern markets, that “why” matters more than people like to admit.
Understanding narratives means understanding that markets are not just information-processing machines. They’re coordination games. And in coordination games, being right isn’t enough. You have to be right in a way that aligns with how others are positioned and how they’re likely to respond.
The best analysis combines structural understanding with narrative awareness. It tracks the mechanical flows and settlement realities while also monitoring which stories are coordinating capital, which frameworks are guiding institutional positioning, and which narratives are close to exhaustion.
Because at the end of the day, markets are made of people. And people need stories to act collectively. The investors who understand this—who can read both the mechanics and the narratives—have an edge that purely fundamental or purely technical analysis can’t provide.
They see the game being played, not just the pieces on the board.