In a bid to create more interest in the financial markets, the industry and the media often indulge in practices that are at odds with investors’ interests, and can be best described as noise.
These could include a broker encouraging a client to trade more frequently (more commission for him), or a journalist writing a sensationalist but meaningless article (more eyeballs and revenue).
Below we outline instances that you can be sure are more “noise” than “signal”, and how you can stay away from them, or in some cases, profit from them.
Too many predictions
The market is filled with professionals making forecasts on different things: stock prices, direction of the economy or whether the RBI will cut rates.
The problem is: with the advancement of technology, and the proliferation of round-the-clock financial news channels and websites, as well as an increase in the number of the financial-services professionals, you will find far too many opinions prevailing on a number of issues that you could do without.
So while most people making predictions will have their own (and in many ways, valid) points in favour of their hypotheses, and investors would do well to educate themselves about different facts and points of view over an issue, tuning out the barrage of opinions could probably be a better choice.
Why? Such opinions could play on investors’ emotions and urge them into action more often than is ideal. For instance, an investor who bought a stock with a three-year outlook could be tempted to sell if the stock fell on some news and a pundit foresaw more problems in the next quarter, when (assuming the reasons for his buying/long-term fundamentals are still intact) the investor should have stood pat, or probably have bought more.
Extrapolation of past into future
The financial media abounds with articles or lists of top-performing funds or stocks (typically during the end of a quarter or year) that highlight recent winners. However, the purpose of such articles should be just that: highlighting winners for readers to pique their interest and prompt them into finding out what drove such performances, and whether conditions still exist that such performances could be repeated in the future.
But many investors--bitten by the recency bias trait that makes them overweigh recent information and expect such performances to continue--take the easier route out and treat such lists as outright buy recommendations.
Similarly, most mutual-fund rankings--including our own Morningstar Rating—which are nothing but backward-looking measures that serve as an indicator of a fund’s risk-adjusted past performance, while being useful for finding and researching interesting mutual funds, are often treated as buy signals.
Pandering to popular sentiment
This partly dwells from the previous point: the average investor often makes a beeline for hot-performing investments (in many cases too late) and the financial media and the industry are only happy to oblige by informing them about/providing such investments.
Thus, you would have seen far more articles written gold last year (after years of outperformance) on why the yellow metal is a good investment than you did 10 years ago. Similarly, we saw the most (and sometimes the riskiest) equity fund launches in 2007 when stocks were on a tear.
While offering investment-product solutions to a willing buyer is one thing, the industry can sometimes start pushing such products to the eager-to-lap-up investor class, regardless of whether it makes a good fit or not, in line with the investor’s need, asset allocation or risk appetite.
Sensationalism
“Five stocks for an inflationary environment” or “Four companies Buffett would have bought” make for interesting headlines for popular consumption but since no one except the person who acted on the advice sticks through to remember whether the given recommendations worked, such articles are often more style than substance.
Focusing on the extreme
In his best-selling Irrational Exuberance, Yale professor Robert Shiller wrote: “In an attempt to attract audiences, the news media try to present debate about issues on the public mind. This may mean creating debate on topics that experts would not otherwise consider worthy of such discussion. The resulting media event may convey the impression that there are experts on all sides of the issue, thereby suggesting a lack of expert agreement on the very issues about which people are most confused.”
“I have over the years been asked by members of the media if I would be willing to make a statement in support of some extreme view. When I declined, the next request would inevitably be to recommend another expert who would go on record in support of the position,” he added.
A half-credible expert who predicts a 100% gain or 50% loss for the stock market this year would make a more interesting headline than a more credible expert who is more sedate with his outlook.
Overweighting the famous
When Meredith Whitney-- a U.S. analyst who had become famous overnight for foreseeing Citi’s problems before the global financial crisis--appeared on a well-known news program in 2010 to predict a wave of municipal bankruptcies in six months in the U.S., it resulted in large-font headlines and primetime news and sparked a run in the municipal bond market in the short run. Only, the “apocalyptic” defaults did not take place anywhere close to the rate which she had predicted.
A prediction, however famous the expert is, is only as good as the underlying facts or hypothesis on one particular issue but the media and investors alike are guilty of attributing too much weight to an opinion if the person is well-known.
Looking at the irrelevant
Journalists tend to focus on aspects of a story that are often irrelevant to the subject matter being discussed. So stocks creating a three-week low, a particular company missing analysts’ estimates by a few rupees, or Greece causing nervousness among traders would find a place in a daily market report when none of it is likely to impact stocks and their long-term fundamentals.
Unnecessary attribution
Nassim Nicholas Taleb of Black Swan fame often points this out in his writings: often financial professionals and journalists are guilty of looking for connections between events when none exist or like to attribute reasons to them after the fact.
So, consider the central bank easing interest rates on a particular day: if stocks were to rise that day, a journalist/analyst could well attribute the rise the rate cut and the boost to economic growth the step would likely provide, but if they were to fall, you could easily find an equally-eloquent attribution to fears the rate cut could stoke inflation.
