The self-fulfilling prophecy is, in the beginning, a false definition of the situation evoking a new behavior which makes the originally false conception come true. The specious validity of the self-fulfilling prophecy perpetuates a reign of error. For the prophet will cite the actual course of events as proof that he was right from the very beginning.  

– Robert K. Merton  from Raji Sethi blog 

Robert K Merton wrote about this issue in 1948 in the Antioch Review

“If men define situations as real, they are real in their consequences”

– W.I. Thomas

When markets deviate from model or valuation expectations, there could a number of reasons for the dislocation. The data used in the model could be wrong. The model itself could be wrong given it is usually a simplified description of reality. Or, there could be a wrong judgment by the aggregated opinions embedded in the market. The story or narrative that is used to describe the market environment could be wrong, a false reality.

Nevertheless, bad judgment can feed upon itself and create further error. Errors can continue for a long-time and have real effects. Think of the simple situation of a bank run. It could be started by a false assumption that then leads to further action that leads to the self-fulfilling prophecy of a failure. The initial definition of reality was false but generated a truly negative consequence. This was described by Merton, the sociologist, not the Nobel Prize winning son, back in the late 40’s. 70 years later, we can still be swayed by false definitions.

False realities can have real consequences. Hence, it is the job of the good analyst to find what is true but respond to the realities presented by the market. Knowing the truth can make you right in reality, but does to mean you will be right with the consequences.