INVESTORS HAVE ALWAYS LOVED A GOOD STORY. FROM TULIPS AND THE SOUTH SEA BUBBLE TO THE DOT.COM BOOM AND NOW AI, NARRATIVES HAVE DRIVEN MARKETS UP IN WAVES – WHICH USUALLY CREST AND THEN BREAK.
In recent years, however, changes to the behaviour of both retail and institutional investors have increased the power and frequency of these narratives, raising the chances of even more severe reversals. How can portfolios prepare?
GEMMA CAIRNS-SMITH Investment Specialist
IN 2025, THE STOCK MARKET DIDN’T JUST MOVE ON EARNINGS; IT ALSO MOVED ON ACRONYMS, AI AND AVATARS.
The TACO trade (Trump always chickens out) summed up a widely held view: Trump’s tariff threats were theatre and would melt into thin air as soon as they met market resistance. So investors always bought the dip.
AI mania added fuel to the fire. Seemingly, if a company merely mentioned machine learning, its valuation skyrocketed.
Then there were the avatars, online personas like Roaring Kitty and Elon Musk who could move billions with a single meme-laced post. In this type of market, perception competes with fundamentals – and often wins.
This dynamic is amplified by behavioural biases common among retail investors. They include extrapolation (assuming that recent trends will continue indefinitely) and herding (following the actions of others rather than forming independent judgments). As narratives and price movements reinforce each other, the distinction between sentiment and fundamental value is often blurred.
POWERS OF PERSUASION
Stories help humans make sense of complexity. Investors today swim in an ever-swelling sea of data, from macroeconomic releases to company earnings and geopolitical events. A simple story, a meme, a tweet, a viral video can slice through the noise, urging us to action.
Investors’ obsession with stories has long been documented in academic literature. While George Soros did not specifically frame his theory in terms of narratives, his theory of reflexivity describes a feedback loop where market participants’ perceptions not only influence prices but also affect the fundamentals themselves, creating self-reinforcing cycles which can drive extreme valuations. More recently, Ben Hunt, our guest contributor, has developed the Narrative Machine for quantitatively measuring how story-driven a market has become.
This dynamic is amplified by behavioural biases common among retail investors. They include extrapolation (assuming that recent trends will continue indefinitely) and herding (following the actions of others rather than forming independent judgments). As narratives and price movements reinforce each other, the distinction between sentiment and fundamental value is often blurred.
This dynamic is amplified by behavioural biases common among retail investors. They include extrapolation (assuming that recent trends will continue indefinitely) and herding (following the actions of others rather than forming independent judgments). As narratives and price movements reinforce each other, the distinction between sentiment and fundamental value is often blurred.
THE DEVIL IS IN THE RETAIL
The modern market ecosystem augments these features. Today’s retail investors can buy or sell faster, more easily and with far greater impact. In the past, stories filtered slowly through newspapers and broker networks. Now they move in real time and en masse. Zero-commission trading lowers the cost of chasing short-term gains, and gamified interfaces nudge users to trade more often. Platforms spotlight ‘top movers’, turbocharging fear of missing out, while social media posts turn stock picks into cultural phenomena.
Memes circulating on social media galvanise retail participation in markets
Retail flows have surged: a recent study by JPMorgan Chase suggests retail participation in the US increased by about 50% from 2023 to early 2025. It now accounts for over 20% of equity trading volume in the US, 40% in India and nearly 80% in China.1 Through Reddit threads, chatrooms and trading apps, retail investors don’t just join the story; they increasingly set the tone, amplify the plot and sometimes even write the ending.
INSTITUTIONAL BIAS
But stories are not purely a retail phenomenon. Professional investors too are often swayed by a compelling narrative. Investor conferences and analyst calls succeed through not just presenting supportive data but telling persuasive stories. Numbers provide the scaffolding, but the story builds the gorgeous palace.
Benchmarking also exerts powerful pressure not to fight prevailing narratives. Most fund managers are judged relative to an index or peer group, not on absolute returns. Taking the other side of a dominant market story jeopardises their fund’s relative performance but also their career. As a result, even sceptical investors often find it rational to ride the narrative.
On 9 April 2025, Trump encouraged investors to buy, fuelling a rally
RIGID ARCHITECTURE
As our Co-CIO Henry Maxey has previously outlined, the market’s current architecture makes narratives self-sustaining, potentially to the point of catastrophic collapse.
Much institutional capital is now governed by systematic, rules-based strategies that respond mechanically to market signals.
Commodity trading advisors (CTAs) and other trend-following funds explicitly scale their exposure based on volatility. Even discretionary managers are constrained by risk frameworks – such as value at risk (VaR) – which rely on historical volatility and price movements.
When markets are calm and narratives optimistic, these models signal lower risk, prompting increases in exposure and reinforcing the prevailing story. When sentiment turns and volatility rises, however, the same models force selling into weakness, accelerating the narrative’s reversal.
One of the other factors supporting existing narratives is passive investing. With passive strategies now representing over half of global ETF assets (Figure 1), capital increasingly follows momentum. These mechanical flows can produce striking outcomes. In 2021, a sudden surge of interest in video game retailer GameStop, driven by investor chat on Reddit, caused its weight in the Russell 2000 to rise sharply. So passive funds tracking the benchmark had to buy more shares, reinforcing the stock’s price and amplifying the meme-driven narrative.
Figure 1 ALMOST 55% OF ETFS AND MUTUAL FUNDS ARE PASSIVE
Source: Bloomberg, Apollo, September 2025
Figure 2 THE THREE STAGES OF A NARRATIVE WAVE
WAVING OR DROWNING?
So what does the current narrative dominance mean for investors? Is the only strategy to join in, hoping the story continues? Are company balance sheets and traditional metrics like price-earnings ratios no longer relevant?
To help answer these questions, let’s consider a simple narrative wave (Figure 2).2 This model shows the fundamental value of an asset staying relatively stable (assuming no structural changes) while narratives push its price above or below that value. The narrative wave has three key stages.
Stage 1 – catching the wave
Narratives usually begin with a kernel of truth, some fundamental strength. At this stage, the asset at the centre of the narrative is often trading below its intrinsic value. Recognising an opportunity at this stage can offer significant upside even before the data improves and the story becomes widely accepted. Crucially, it usually also has limited downside, as the price is low.
One recent example was gold mining equities. In 2023 and 2024, we observed a notable divergence. The price of gold bullion was steadily appreciating, partly because central banks were buying after Russian reserves were sanctioned. However, gold mining stocks remained largely stagnant. This was unusual. When gold prices rise, mining equities typically outperform bullion.
We viewed this as a classic Stage 1 opportunity: an asset with asymmetric potential, where the downside appeared limited and the upside was underappreciated. So we steadily built the portfolio’s exposure. Over 2025, the narrative caught a wave, as investors gradually came to appreciate the fundamental value mining equities offered.
Their costs remained constrained while their margins were consistently expanding as the gold price rose. As a result, gold miners dramatically outperformed bullion in 2025, with major producers such as Barrick and Newmont posting returns roughly double those of the metal itself.
Recognising the seeds of a new story can help position investors ahead of a coming wave. But it rarely feels comfortable, particularly when benchmarking dominates. It often means allocating to unfashionable themes, holding assets others dismiss and enduring stretches of underperformance. Yet, if you get it right, today’s overlooked ugly ducklings can transform into tomorrow’s beautiful swans once the narrative shifts.
Stage 2 – riding the wave
A defining feature of narrative-driven markets is their resilience. Once embedded in investors’ minds, stories tend to persist well beyond what the fundamentals would justify. Often they last until evidence that the narrative is overblown can no longer be ignored or until a more compelling counter-narrative emerges.
This persistence increases the opportunity cost of remaining uninvested in a prevailing market story.
The AI story offers a live illustration of these dynamics. While it may be too early to say the wave is cresting, it is increasingly flashing warning signs. Market enthusiasm has driven extraordinary valuations, concentrated in a handful of mega-cap US technology firms. These valuations, along with questions about the return on their enormous spending and emerging signs of speculative financing, suggest sentiment may be outpacing prospective returns. Investors appear to be getting swept up in the story, potentially making choices that, in hindsight, may look imprudent. Surfin’ US AI may end in a wipeout.
Stage 3 – wipeout
But a narrative can only suspend reality for so long, and monitoring for the crest of a wave is critical to preserving capital. When prices stretch too far beyond the fundamental value, the risk of a violent reversal increases significantly.
History shows how dramatically this shift can play out. GameStop lost nearly 90% in just over 20 days from its 2021 peak once the meme-stock frenzy collapsed. Even Nvidia, the current market darling, has a history of severe pullbacks. Since its IPO in 2000, Nvidia’s market cap has halved on seven occasions (in 2001, 2002, 2004, 2008, 2011, 2018 and 2022). In the dot.com bust, the Nasdaq plunged nearly 80% over two years. And today’s new market structures, so far untested, have evolved in ways that may intensify these dynamics, making the next unwind potentially even more severe.
WHEN TO EXIT THE WATER?
Ultimately, the wave framework underscores the need to balance narratives with fundamentals. Stories can drive markets for extended periods. But the fundamentals remain the anchor. Investors who dismiss prevailing narratives risk missing potential gains; yet those who ignore the fundamentals will be most exposed when sentiment inevitably turns.
In an ideal world, you would time the crest of a narrative wave by identifying the peak of investor enthusiasm and the point where prices diverge meaningfully from fundamentals.
In reality, attempting to exit at the peak risks staying too long and being caught in a sudden reversal. When a wave appears overextended, it’s usually wise to avoid it altogether, prioritising capital preservation over chasing the wave’s final gains. Standing on the sidelines may feel painful. But that pain can be mitigated by identifying the emerging waves of the future.
At Ruffer, we remain firmly focused on prices and fundamentals. We do not try to time the market, which we believe is next to impossible. We constantly ask ourselves, “What if we’re wrong?” This helps us stay disciplined and prepared for a range of outcomes. Waves today are more frequent and powerful than in the past. But the larger the wave and the stronger the narrative, the greater the impact when it ultimately breaks. Constructing a portfolio that balances protective assets with exposure to emerging waves should achieve more consistent returns. ⬤
1 Spear (2025), World Economic Forum 2 Beutel Goodman (2024)
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