In Part 1, we saw how the media noise can distract us from investing. Like Warren Buffett, we should be focused on the long-term prospects of our investments but, the media noise clouds that objective. In Part 2, we’ll take a closer look at how investors overreact to the media noise and discover ways to keep our eye on the prize.
A headline that reads “Traders Confused, Market Direction Unknown,” while completely accurate, does not justify a journalism degree, nor does it help media company directors earn their pay.
Thus the media, particularly television and fast-paced online reporting, attempts to draw patterns from confusion, to connect the million tiny choices of the market hour-by-hour to some larger, human reality. The effect, of course, is to dramatically increase the noise in the signal. It’s like that old kid’s game “telephone.”A phrase is whispered from one child to another around a circle. By the end, even the simplest of messages is garbled beyond recognition.
Yale University economist Robert Shiller tackled the subject of financial reporting in the Spring 2001 Harvard International Review. In an article entitled “Exuberant Reporting: Media and Misinformation in the Markets,” he touched on the problem of “attention cascades,” that is, the way markets tend to absorb not only the immediate headline but also the reaction to the news, often overreacting well after the fact.
“The role of news events in affecting the market seems often to be delayed. Attention may be paid to facts that are already well known. The facts may have been ignored or judged inconsequential in the past but attain newfound prominence after some news event,” Shiller explained. “These sequences of attention may be called cascades, as one attention-getting event leads to more.”
The Contrarian Way
Shiller uses the example of the 1995 Kobe earthquake. A strong one, at 7.2 on the Richter scale, the initial quake news seemed to have little effect on markets. Nearly 6,500 people died and the damage was counted at $100 billion. Investors did not flinch.
A week later, however, the Nikkei slid 5.6 percent, then a total of 8 percent over 10 days. London, Paris and Germany followed suit. Even Brazilian and Argentine stocks fell. It’s wasn’t the quake but reaction to it that led to stock declines thousands of miles away in loosely related markets.
In theory, a much better approach to consuming financial media — assuming you can’t take Buffett’s advice and tune out for a decade — is to try to understand how human perceptions of events can lead to opportunities to buy value.
The first step, of course, is to learn how to correctly value an opportunity in front of you, to use Buffett’s tools to grasp when a bargain truly is a bargain.
The second is to embrace the contrarian way: When you see a chance to get into a long-term position at giveaway prices — a chance that might well come from an unexpected attention cascade, well after the news is no longer new — that’s when you buy.
If market-timing is not your style — and for most it should not be — one way to dampen the effect of media noise is to buy a selection of index funds or ETFs rather than individual stocks. Like mutual funds (only far cheaper), ETFs and index funds put you into entire sectors at once: the S&P 500, for instance, or the Russell 2000 small caps.
Tuning Out for Life
It is very hard indeed to find much actionable information in the news when you own a little bit of everything, so you are less likely to get panicked out of a single position by “breaking” news that will turn out to be meaningless minutes after you sell.
Index investing does not absolve you from making choices. You do, after all, have to design an asset allocation in line with your goals and tolerance for risk. Once you have the allocation in place, however, you will find it easier and easier to tune out the noise of financial media entirely and instead focus on your strategy — and on the other things in your life that truly matter.