To investors worried about the direction of volatile markets over the next few weeks, fear not. I have some good news for you. The impact of US President Donald Trump’s tariff tantrum is abating. The markets are back to normal – at least for now.
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But to understand why markets have somewhat recovered, albeit temporarily, we need to review how the system for pricing assets works. Prices don’t need to move substantially if there is no relevant news; rather, they remain in a steady state between buyers and sellers.
When news does arrive, it injects energy into the system and disturbs the steady state by providing additional information about future expected asset value. News feeds market narratives, and narratives move asset prices. This is the fundamental theory behind narrative finance.
The price system factors in the importance of news inputs, prompting a price change. This news develops into a narrative influenced by factors like legacy narratives, behavioural aspects and the climate of contemporary geopolitics and geoeconomics.
Of course, not all news is the same. A routine or insignificant piece of news adds little energy, but a high-energy piece of shocking news leads to a big change in price, destabilising the system’s steady state.
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In other words, price changes influence the entire pricing system. Low-energy news has a minimal impact on the steady state, as the feedback is negative. Meanwhile, high-energy news significantly impacts the system, which will struggle to adapt. This can lead to disorder and even a breakdown of market prices – a process known as positive feedback.