Consensus progresses through several clear stages as group beliefs coalesce around certain ideas.
The purpose of consensus is to define group beliefs that shape action and ultimately outcomes. There are both formal and informal manifestations of popular opinion, but the formal ones are the easiest to describe here. Two of the most common formal creations of consensus are prices and policies. It is always useful for the contrarian to know to know where we are on the path of consensus when placing bets as an investor or assessing the landscape as a voting citizen.
Markets and Prices
In financial markets, prices reflect consensus belief. The price of an asset represents the market’s opinion about that asset’s forward prospects based on information available at a given time. A stock with a seemingly “high” valuation given today’s business performance must be expected to have a bright future with rapid growth in revenue and earnings. A stock with a “low” valuation given today’s business performance must be expected a long-term loser. Contrarians try to create extraordinary returns by identifying assets that are mispriced by consensus.
Prices change in a direct and dynamic manner as the thinking of market participants evolves. Real-time price changes are a necessary feature of free markets. For markets to be anywhere close to efficient — of course they aren’t completely efficient — they must be free, and free markets must reflect the changing attitudes of unencumbered participants as they happen.
The stages of consensus evolution in markets look something like this:
Early on, non-consensus ideas have few adherents. If everyone believed from the beginning, the idea wouldn’t be non-consensus. As an idea catches on, more of the group pays attention, and prices increase, as represented by the line on the graph. Of course, pricing is never as smooth as this line suggests. The line is only intended to show the directional path of prices as consensus evolves.
Eventually, the idea hits a tipping point and quickly becomes consensus in the market. This may happen in a matter of days or months or years, but when an idea takes hold, prices start to move in an undeniable manner, and market participants often pile into the trend. Some may do deep work on the idea before jumping in, others might just follow the herd, but the outcome is the same: The idea becomes consensus, reflected by higher relative prices driven by demand from the growing consensus.
Over the last 12-18 months, electric vehicles have gone through this acute transition phase. No rational person can say that EVs aren’t consensus when looking at the valuations and price movements of any stock that touches the EV theme. Over the last few weeks, we’ve seen another transition phase in the market, which is a consensus belief in rising inflation. There always seems to be someone sounding the alarm about inflation, but this time the movement in bond prices and resultant yields tells us that concern about inflation is becoming a consensus idea.
Beyond the transition phase, an idea is firmly consensus. That doesn’t mean there isn’t more upside, it just means there are far fewer incremental buyers into the idea. As an idea turns out to be right, more money can flow into that idea from existing buyers or a few laggards and additional returns can be had, but they won’t be extraordinary as they were in the enlightenment period of consensus. In the end, an idea runs its course, and the trade is over. By that time, contrarians should have long moved on.
The above drawing and progression show what happens when a non-consensus idea matures into being right, but non-consensus ideas are often wrong. Many non-consensus ideas never get any attention from the broader group and die a quiet death in the first two phases. The more interesting ones capture the attention of consensus and go through a very public death.
The public death of an idea may be because the idea is bad, or it may just be early. The internet went through the above progression in 2000-2001, only to reemerge as non-consensus ideas that ultimately worked.
It’s no coincidence that the stages of market consensus correlate to the stages of technological adoption as identified by Everett Rogers. The evolution of consensus and technology both reflect the emergence of something new, whether a product or idea, that permeates a group of people. All new things start with early believers, often later seen as experts, that champion the new thing. Then early adopters of the new thing emerge, until the thing quickly builds into a consensus belief with a tail after a huge spike in acceptance.
New technologies are destined to become consensus if they deliver transformative results to users.
Politics and Policy
Whereas prices reflect formal consensus in markets, laws reflect formal consensus in politics. There is a major difference in how consensus progresses via law relative to prices. Policy change isn’t represented by an exponential growth curve like prices, but by a step function. It’s a binary act. In formal terms, an idea is either a law or it isn’t. Policy changes must happen in rigid, binary terms rather than undulating market waves because if laws were flexible and changed all the time, the people would have no certainty in action.
While policy is binary in an absolute sense, the progression from not policy to policy is a hybrid of both growth and step function. Like markets, policies have early champions of an idea. Those champions start to gain attention for the idea, and support grows. As support grows for an idea that isn’t yet law, social norms evolve and reflect in voter preferences. Voting is a formal consensus mechanism that determines who establishes law, and if the people vote enough supporters of an idea into office, the idea becomes law.
In the case of both prices and policies, especially policies, consensus doesn’t mean that everyone agrees. It means the prevailing belief reflects itself in how the group acts. In markets, acceptance of the prevailing belief is a free decision of participants who are guided by financial incentive to be right. In policy, acceptance of the prevailing belief is demanded by legal enforcement by the state.
Like market corrections when consensus turns out to be wrong, laws can be overturned and changed through the same mechanism. Beliefs among the voting population can change, and those changes can result in electing new lawmakers with new ideas.
While the evolution of social norms that precedes the establishment of law happens more like the free market mechanism, the intransigent minority that changes norms has far more power than the market minority in changing prices.
The Intransigent Minority
Nassim Taleb described the idea of the intransigent minority in Skin in the Game. The basic concept is that, in some cases, a small group of unyielding people can dictate group preferences, even if the rest of the group does not share the preferences of the minority.
The intransigent minority is very relevant to the formation of policy, but not usually prices. Free markets aren’t subject to the demands of an intransigent minority. Prices can only move meaningfully when consensus comes to believe in an idea because prices depend on supply and demand. A small minority can almost never create sufficient demand in a broad, liquid market to meaningfully affect prices. In an illiquid market, a seeming minority could very well be the majority.
When an intransigent minority assumes power, it demands the change of social norms, and ultimately policy, without consensus support. The minority may exercise power by way of broader group apathy about a certain topic, or by forceful coercion. Those who disobey may face social or legal punishment.
The distinct feature of rule by intransigent minority is that the action dictated by the minority never becomes a consensus belief. This results in a volatile relationship between the intransigent minority and those from consensus who speak up. Intransigent minorities must defend their position forcefully out of knowledge that their power is only valid to the extent that consensus cedes it to them. All of this plays directly into our prior discussions about extremes naturally earning attention and experts being ideologues. Perhaps something to explore another day.