(Ep. 48) How Narrative Momentum Predicts Market Shifts Before the Data | Ronnie Sadka

Welcome to the Ideas by Mike podcast. This is Mike Milligan. I'm excited to bring an important guest to the conversation about momentum and more specifically narrative momentum. Ronnie Sadka is the chair of finance at Boston College, among many other accolades that he has accomplished that we'll talk about in the show. But one of the things that we're gonna address on the show today is how narrative momentum, his Through academia as can help you with a diversified investment portfolio. We'll even talk a little bit of tap dancing before it's all said and done. Welcome to the Ideas by Mike podcast. Ronnie, I appreciate this conversation today for our audience. Um, and I want to start with, uh, with your academic path from the University of Washington to NYU to the University of Chicago before accepting your tenured position at Boston College. Uh, but I want to speak about one of those stops along the way, uh, a little bit in detail. Could you elaborate on what made the University of Chicago an unbelievable experience and how that environment, including research that they're doing, influenced your work later in financing, in the finance world.

Sure, Mike. Good morning. And by the way, thanks for having me. I'm very excited to be on the show. Yeah. So look, I've been fortunate to be in many universities. University of Chicago is specifically in our field of finance or empirical finance, has really generated a lot of important works over the last several decades. And, uh, it's a place that really kind of inspires a lot of, you know, young junior faculty. I, I just thought it was a great opportunity to go there and, and, um, hang out, learn from professors that are top in the field since I have left, actually, 4 faculty members, I think 4, have received the Nobel Prize in Economics for their contributions. So it's definitely, when I was there, it was a very vibrant place and I learned a lot. So they're known really for research in empirical finance. One of the things that came out of there is thinking about market efficiency, thinking about different Um, I guess characteristics of, of firms and risk of firms that might lead to prediction in their, in their expected return and their performance. So people thought about, you know, size effect, market cap, and, and value, like a book-to-market ratio, value investing, a lot of, uh, things that people talk about today, like style investing, momentum investing, were significantly studied at that institution. So for me to go and teach there and be part of that was very satisfying.

So we often, in the academic world, we always talk about the Wall Street world versus the academic world. And they're distinctively different because Wall Street is like the here and now. The academic world looks for trends that go Much longer in detail. They have the ability to see things that happen before they come. And often Ivy League schools are credited with a lot of that. The Wharton School of Business, Yale, like Shiller, Siegel, a lot of other big names have come out of those. But this whole idea, like you called what you studied at Chicago something that we haven't never talked about on our show before. Can you explain a little bit? about why momentum and some trends that are happening that you guys, you know, that you trained on at the University of Chicago and that now you're teaching and building indexes on. Can you talk about why that's so important for the next 25 and 50 years or even for today?

Yeah, I think the things that I'm working on now are not necessarily new ideas. I think that the real added value here is that we have some technology that is better able— enables us to really implement ideas that I think were there. I mean, when you think about the Shiller idea of narrative economics, I think it's a fantastic idea. I think the issue is how do you actually take that and implement it into a trading strategy, or how do you first understand it economically and test it, and then how you can actually implement it to a trading strategy. So that's one of the things that I've been really focusing on in the last, I want to say almost a decade that I've been really trying to bridge this gap between technology and finance.

So let's, a term that you introduced me to is narrative momentum. It's that your research leverages that technology for this term by analyzing millions of articles daily. That just blows my mind, by the way, that you could do millions of articles daily. And it's not just you've been doing it the last year or two, you've been doing this for over a decade. Can you specifically, can you track with over 1,000 narratives going on at one time and your focus is on the slow-moving ones that might be suitable in today's world? Can you provide a more concrete example? Well, first of all, can you define Narrative momentum. And then can you provide an example of a slow-moving narrative that you've identified in your research?

Sure. Let me just actually start by explaining to people what's the economic underpinning of the strategy we're going to be talking about. So I think that narratives drive the market. Okay? What does that mean? Say you're a trader on Wall Street. You hear things happening, you hear news, you hear people talking about different trends. And what we're trying to do is to quantify the narrative. So we don't necessarily think that the market is driven by a size factor or a value factor or a quality factor. We think the market is driven by narratives, by people talking about trade war, by people talking about social unrest or people talking about liquidity. So the narrative of what people are talking about, I think that drives financial markets. People respond to stories, they respond to information, new information in that way. The challenge is how can you actually quantify that? So, so what we've done, we, we create— think about it as almost creating a copy of the internet every day. It's not exactly like that, but what we do is we go and we tap into digital media sources every day, and we automatically, systematically collect this information from media coverage, and we try to understand what people are talking about. So in terms of the size, the amount of information, you're right. It's about a million articles every single day. And then we look at, you know, we use natural language processing, or now people are going to use LLMs, And we can try to understand what are the topics that people talk about. And what we see is that topics are really driving financial markets. They're driving single-name securities. They're driving the market as a whole. They're driving commodity prices, FX prices, sectors, you name it. So we think what we're trying to do is really to capture that correlation between security price movements and the discussion of different narratives in the market. Does that make sense?

It does.

So I want to get to your question about the narrative momentum, because what we're saying is we're able— we, we're using technology now available to understand topics, and we want to show that the topics are, are, uh, in our research, what we do is we show that the topics are correlated with the financial market prices. So when you look at at the market overall or stocks or bonds, whatever. And they move with the discussion of the different narrative. So now we're talking momentum. I want to get to your momentum question.

Yeah. Before we go to the middle, can I ask you a question that we talked about previously?

Sure.

So like the news, the, like the news cycle narratives.

Yeah.

One of the things that you shared with me previously is that in the discussion along the way, so let's think about like 2019, you guys started hearing about this virus overseas way before it came. Is that correct?

Right. So, because we look at all media coverage, let me kind of help people understand. So, it's not really a black box. There's all sorts of media. There's general press media, right? Like the Wall Street Journal, USA Today, Financial Times, uh, etc., Washington Post. So we have that general press, but there's also a lot of trade magazines like Pension Investing Magazine, Absolute Return Magazine. There's, there's, um, magazines, FX-based, uh, magazines. There's press releases of companies, there's social media, there's all sorts of media. What we do is we, we organize this information in different reservoirs. We call them reservoirs of information that the reservoirs are really trying to capture a particular type of media. And my comment to you on our early conversations is when we kind of look systematically at the different reservoirs in the media, we saw that in the FX reservoir, for example, FX reservoir, our media coverage that talk about foreign exchange. So these are typically kind of more traders talk about these. And we saw that there was a mentioning of pandemic coming already mid-January. So, this is— we're talking about more than a month before the general press picked it up. So, we really understood that there was something going on. We didn't know it wasn't coined COVID-19 yet.

Right.

But people talked about pandemic happening. And people have been talking about pandemics for a while, right? We had the H1N1. We have all sorts of, you know, flu. But this one, we just saw a huge increase in the amount of coverage in a very, very small time. Like, the intensity of coverage was really high, and it happened before the corporate communication talked about it, general press releases talk about it, et cetera. So, that's the way it got that narrative in our system.

Okay. So now, because it talked about it ahead of time, that's where the momentum comes in, correct? And so, that's where It builds momentum to then be able to start making decisions or at least theories when it comes to investments, correct?

Exactly. So, what is narrative momentum? So, we talked about narrative, right? So, I think that's something people can now understand, narrative discussion. Okay. But narrative momentum is a phenomenon whereby people are talking about the narrative and it's gaining momentum. So we're looking at, because we're looking at FIA market, we're looking at narratives that are kind of slow-moving narratives that takes them, let's say, 6 months to pick up in discussion. So the pandemic was, was gaining momentum, but it was relatively kind of a short momentum. It happened really quickly, right? Like a meme stock is also an idea of, of a narrative that happens really quickly. What's a narrative that's gaining momentum slowly? For example, inflation. Inflation, remember after the pandemic, right, started, let's say, 2000, end of 2020, 2021, people have been talking about inflation. So we've seen inflation discussion going up, even though we didn't see CPI moving, right, though we saw inflation discussion going on. And only in January 2022, we started seeing really indications that inflation is happening. But we have captured that narrative momentum even a year prior. So what we're trying to do is in any given point of time, understand what are the narratives that have been gaining momentum and kind of slowly moving up. That's what we're trying to do systematically in our system. And what we've shown, our empirical results show that people tend to underreact to these narratives that are slowly going up. So if a narrative like inflation has been discussed for like 6 months and over and over and kind of again, it's going to gain and gain momentum. It's kind of under the radar. People don't pay attention. So if people don't pay attention to it, then once they do, then security prices will respond. So the entire idea of this strategy is to say, yeah, narratives affect security prices, but because there's narrative momentum, We can actually have some predictability and we can place— we can design a strategy that would place positions in securities that we think are going to respond given to the momentum in the narratives, in the underlying narratives.

A lot of people will say that the market has full knowledge of everything. Do you, do you buy into that, into that statement?

I think it's not like a zero-one question. I think the market on average, I think, is efficient and we have a lot of it. A lot of examples. Well, we call it semi-strong efficient, that public info, public news goes into public information is is quickly adapted into into security prices. So I think we see that overall when there's let's say earning announcements and and or or the Fed meets, and we see immediately if you look at intraday, you can see exactly you could pinpoint when you know the news came out. But there's a lot of other type of news and, as I said, narratives that are kind of slowly gaining attention under the radar. And I think people sometimes don't pay attention to everything. The reality is we have some kind of bounded rationality. We can't, we just can't process so much information at the same time as humans. So maybe I can figure out, I can think about 2, 3, 4 things in a given day and I pay all attention to that, but then I'm going to miss all the other stuff. So This is a way to systematically understand what we're missing and helping us, let's say, improve market efficiency because we can overall understand in any given point of time, what are the narratives that have been kind of under the radar?

A lot of times when news is moving so rapidly, like the Fed meets and people make snap reactions. Right. COVID is an example of rapid.

Yeah.

But the interesting part about that rapid reaction to what happens in the modern, modern news is that people underreact to actually narratives that have been informed because they don't, they don't see them. They can't sense them.

Right.

Because, because life is busy. Let's get for real. People, people go and they, they don't spend every minute of every day in the markets. They go and they do things with their kids. They go on vacation. They live life. And so there's a lot of this missing of these underlying narratives that are forming. So why is the method of identification and quantification of these narratives so critical to an overall portfolio?

I think it's it captures different types. It captures a really it's a different type of profile of portfolio. It captures a different type of of investment. What you said at the beginning about about the pandemic or the Fed meeting, these are also examples of narratives. It's just that when they happen so rapidly, people tend to respond so quickly and actually sometimes overreact to them. They end up. Overreacting. And so we can see some price reversals after such overreaction. So you could also take advantage of price reversals, but that's going to be a much more high turnover, high transaction cost strategy. So we tend to— for this market, we tend to focus on the narratives that are kind of slowly moving and have momentum rather than these narratives that are explosive And typically display a reversal to them. So what we're trying to do again is understand narratives that are slow moving. The narratives that we're capturing are not always the narratives or financial ratios that people look at. We look at things as— let's think about it— like pandemic, liquidity, social unrest, trade war, momentum investing as a discussion, not as looking at the price, whether the price goes up. We're just looking at if people talk about it, carry investment discussion. These are the, the things that we, we, we look at, and it's very different than, let's say, like a value investing or, or a straight price momentum or, or size or quality. So these are just our stories, our, our narratives that people are discussing, and people understand them and in everyday life. I think people understand when you think about inflation or you think about a recession coming or any macro thing. People, I think, understand that. The trade war, they understand that. But how do you move? How do you represent a trade war narrative in a security strategy? How do you do that? That's one of the things that we do. That's what's so interesting about the strategy. It takes the identification narratives and translates that to a portfolio that tends to outperform because of the narrative momentum.

Early in my career, so as a practicing financial planner, I don't have time to academically research everything or dive in as much as I want to. So early in my career, I had an idea. I was like, why don't I just go in every day to the market, And this was back in 2006. So this was early in my career. Why don't I just go every day in the market? I'll pull up a list of every stock that was down by 5% the previous day. And I'll just look to see what it does the next day. If it goes down again, then it's a great buying opportunity. It was an awful idea. It was because in the grand scheme of things, what I was looking for is like the trampoline effect. I was just looking like things that go down are going to hit a trampoline and go back because If you think, remember the times, 2000 to 2007, when I had this idea, it was good, right? And you know what I learned is that you're going to win some and you're going to lose some. And that's why we always talk about diversification. And so my idea of seeing if I could outperform the market in my personal portfolio and clients' portfolio was to see if the trampling effect was true with the percentage of their assets. It just wasn't. Academically, it proved it wasn't. The reason things go down in value is because the narrative or news cycle forces them to go down, or there's something bad happening in the company. They're not earning money. The management has changed. Something has happened. And so the trampoline effect is not something that's actually really real out there in the market. But this whole narrative that we're talking about, the slow-moving, of narrative momentum is something that you have tracked for longer than a decade. So why is it so— where my idea of the trampoline effect is not a real idea, your narrative momentum is one that has gained traction over a long period of time. Why is it so important today for people investing in the markets?

Well, I think it's especially important because I think even Today, the market is even more narrative-driven. I mean, you think about what we've had over the last year, right? Think about the discussion of trade war. There is no trade war security. There's no vehicle where you can just say, oh, let me invest in trade war, or let me invest in liquidity.

Oh, wow.

There isn't any. So our solution is first to understand that that's a discussion that is important and people talk about. And the second part of this whole solution is how do you connect between the discussion of the narrative and the security that we think should be traded? So that's a whole— that's another aspect of this project. One is understanding the narratives and understanding that there's narrative momentum. And then the other is how do you design a well-diversified portfolio that would tend to outperform when there's more narrative momentum? So I can maybe— let me just talk a little bit about how do we identify an asset that we think is a good candidate to be traded when there's narrative momentum. So let's take the example of, you know, we talk about inflation.

Okay.

And we look at the discussion of inflation over 6 months, we see it goes up, right? So how do we know which asset to buy? So here's what we do. We look at— let's say you look at the universe of all large-cap US equity firms, okay? Let's say we look at the top 3,000, okay? And what we do is we look at weekly returns of the stock and we correlate that with the weekly changes in the discussion of the inflation narrative. Okay, so what does it mean, discussion inflation narrative? We mentioned you have about a million articles a day, right? So we calculate what's the percent of articles that talk about inflation. That's going to be a number. That's how we move from something that is intangible, like a story, to something more tangible, which is percent of articles that talk about inflation. So you look at the percent of that article, maybe it's 0.1% today, and maybe tomorrow it goes up to 1%, and maybe it goes down the next day, whatever. So we're just going to calculate what's the average percent of discussion of inflation on a given week. And we're going to look at that over every week. And let's say in any given point in time, we'll look at the last 52 weeks, like a year worth of data. And correlate this— a stock's return, weekly return, with the intensity of discussion of the inflation narrative. And that's going to give us some kind of a correlation or exposure of a stock to that discussion. That means the following: if there's a week that, um, that many people are talking about inflation, did this stock go up or down? If it goes up, it's going to be positive exposure to the inflation narrative. So we're going to do that analysis across many, many assets and many, many narratives. So we're going to look at individual firms, we're going to look at sectors, we're going to look at FX, we're going to look at commodities, we're going to look at safe assets like gold or US Treasuries, et cetera. And we're going to look for each of the securities, How do they respond to each narrative? So how do we take advantage of narrative momentum? At any given point of time, we look at what are the narratives that have gained momentum, and then we're going to just buy the securities that have a positive exposure to that narrative. And because of narrative momentum, we expect those that have a positive exposure to recently increasing narratives We expect them to outperform the future because people tend to underreact to it. So that's the whole strategy. It's, it's doing everything I said systematically. Every month it kind of looks back at all securities and all the asset classes that we talked about, looks at all the narratives that we have in our system and looks at which ones went up and which ones went down, and then picks the stocks or commodities or any asset class that have exhibited a positive exposure to the narratives that have been increasing. And we rebalance that every month.

And likewise, when a stock that's already in Market Trends portfolio starts getting negative press that is not going, you'll then move it out of the portfolio, right?

That's right. When they're getting less attention. So if people just don't talk about it anymore, Yeah. Let's say inflation, maybe if— maybe it would— it had a narrative momentum and then it kind of— people said, okay, maybe inflation is, uh, receding. And so if, if there's less discussion of it, then, then the assets are, are going to be taken out of the portfolio, or sometimes they're going to be actually shorted. So it's— everything is again being done systematically in the way that we think about momentum. If there's a gain in momentum, we're going to buy. If there's a decline in momentum, we're going to sell. So that portfolio is going to be well diversified, many asset classes, both in the long and the short that are tracking the narratives that are in momentum.

That last 5 minutes was a masterclass in describing momentum. We could tell that you have the heart of a teacher, but the genius of somebody that sees something before it happens. Ronnie, there's a couple ways for people to get access to Market Trends. We obviously have access to that as an index inside of Nexus products, but how else do people get access to your research, or how can the individual learn more about Ronnie and Market Trends?

Well, look, I'm Part of me is a public good, right? So, I'm an educator. I teach finance. I'm the chair of the department of finance at Boston College. I'm also senior associate dean for faculty. So, I do all that so that I can go on my webpage, et cetera. But I also co-founded this company called MKT MediaStats about almost 15 years ago that really takes these ideas and brings it to market. And there's just a lot of development on that side technology-wise to kind of bring this idea to completion, to really bring it to the market. Ideas is one thing, but maybe it's like 90% execution.

Right.

And to do that in a seamless way that you would have no issues, portfolio rebalanced every month, everything I said, This is done systematically without any intervention. This is systematically done. Bringing all that to completion takes a really dedicated and talented team to do that over a long time. So that's not just a professor that thinks about ideas. It's really—

Right.

A lot of it is about execution. And so, you know, we really appreciate this partnership with Annexus, and we've partnered with MSCI as well to create this index. And it's been a wonderful journey so far, but I really think this is tackling an angle in the market that is untapped. I think it's not an easy thing to do, and I think it all kind of makes sense. It takes the economics and translates it to really a tradable strategy that I think a lot of people can understand and can relate to. And the real reason it works is because this is I think how people really behave. Right.

Roddy, obviously you are one of a kind. That's one of the great things about my company, One Oak Financial, is we always talk about being one of a kind. As we end today, what is one thing that people may find fascinating about you outside of the economic world, investing world, teaching world? What do you do that is that is unique to kind of refill your tank on a daily basis?

Well, I think people are multifaceted, so you have to— I think you shouldn't be just what you said earlier, trading all day. I think that's not a good— I'm not sure that's a good idea. You need some perspective. But, you know, my life is full, you know, with family and being a professor and co-founder. I guess if I would mention maybe one thing that I used to be when I was young, before I became an academic, I actually used to be a tap dancer.

This is a first. This is a first on Ideas by Mike. This is a first on my show that I have a tap dancer. That's good.

There's something about showbiz, I guess, or it creates, I think, a lot of confidence when you're on stage. And I've done that when I was very young before. I think I stopped when I was 15. That's when my grandfather decided that, hey, you got to do something with your life. So I went more the academic route. But I think that helps you with just being on stage as a teacher.

Yeah.

A lot of it is you need to captivate people's attention and thought. And I think being on stage at a young age helped me perform today.

Do your kids know that you were a tap dancer?

Oh, definitely.

Oh yeah. I bet they still every once in a while ask you to get out and move your feet a little bit.

Yeah, yeah. My mom shows them videos.

I bet. Ronnie, well, that was an absolutely great conversation about about University of Chicago, about the narrative momentum and how it applies today. And then we even learned that you're a tap dancer. So we're going to look for Ronnie Sadka YouTube videos on tap dancing in the future. But thank you. Thank you for your time today. Thank you for the wisdom, for bringing a different approach. Your ideas have come to fruition. And it's going to help change retirement for many people through a diversified portfolio. So we appreciate all the work you and your team are doing.

Thank you very much.

Thank you for logging in and listening or watching. To another episode of Ideas by Mike. If you want to learn more about my firm, One Oak Financial, please visit us on our website at www.oneoakfinancial.com. That's the number oneoakfinancial.com. If you enjoyed this podcast, you could help me by liking it, subscribing to our channel, and telling others about what we're doing. See guys, we're looking to change the game, and that game is about making financial planning more about you. Until next time, this has been Mike. CFP Board owns the marks CFP®, Certified Financial Planner, and CFP® in the United States. As a reminder, Mike Milligan, Certified Financial Planner, is an investment advisor representative of Advisory Alpha, LLC, an SEC-registered investment Advisory firm. All opinions expressed by me or our guests are solely our own opinions and do not reflect the opinions of Advisory Alpha. This recording is for informational purposes only. It should not be relied on for investment, tax, or legal decisions, and it's in no way intended to communicate or guarantee specific performance or suitability of any security instrument or product as we may have discussed. Investment advisory and financial planning services offered through Advisory Alpha, LLC, a registered investment advisor. Insurance is offered through Ideas by Mike, a Virginia-based LLC here to serve you in all 50 states and the District of Columbia. Ideas by Mike is a separate and unaffiliated entity of Advisory Alpha, LLC. While tax and legal issues may be discussed in the general course of financial and investment planning, Advisory Alpha does not provide tax or legal services. Please consult with your tax or legal professional prior to making a decision relative to those decisions. Any and all statements of purported or observed general practices of non-affiliated firms and advisors or conditions of the broad financial services industry are solely the opinions of Mike and are not intended to be offered as factual. The validity of these statements has not been verified, and as such, no representation of their validity are made. An annuity is a long-term financial product designed largely for asset accumulation and retirement All guarantees are backed by the claims-paying ability of the issuing insurance company. This podcast is produced in conjunction with Mike Milligan LLC. Thank you again for joining us today. We'll see you on the next podcast.