The Causal Chain from Sentiment to Price to Valuation

Markets are future-oriented by nature, seeking to price in today what may occur tomorrow. Every market outcome requires human action and interpretation to commit capital to an unknowable future. Because the future is unknowable, no aspect of price formation is independent of sentiment, rendering the search for objective residuals that are free from subjectivity impossible, irrational, and incoherent. The result is a tripartite crisis that cannot be eliminated or engineered away, only navigated through sentiment.

This crisis is the result of the intrinsic subjectivity (the innate permanence of subjectivity in market activity) that creates structural uncertainty. We see this originating at the individual level, manifesting at scale, expressing through a multitude of channels, then amplified and transmitted through market structures. Every analytical or theoretical tool at our disposal from statistical models, to discounted cash flows, to hypotheses on efficient markets, even the metrics we use to quantify risk and volatility, have sentiment at their core. It is erroneous to think of valuation as a compass that points to a True North, valuation is more like a magnet that we use to pull the needle toward wherever we believe the crowd should go. No matter the formulation, sophisticated market analysis remains derivative of the subjectivity that forms the substrate of the market.

The arguments presented in this essay reveal how sentiment flows through the market, from origin to expression, in a clear causal chain: 1. Sentiment initiates the conviction that commits capital. 2. Price records the settlement of competing convictions. 3. Valuation rationalizes the distance that settlement has traveled from its agreed-upon anchor. It is the role of the investor to refrain from pursuing a truth that markets cannot contain and develop the discipline of forming beliefs that markets cannot easily displace.