Don’t know who the fool is? It’s probably you
FREE email from MoneyWeek
Discover the latest profit opportunities and understand what’s really going on in the investment world with our punchy daily email. CLICK HERE
This genius investor does dizzying levels of research to uncover...Half Price Shares!
At first glimpse, the title might seem a trifle off-putting, but the article justifies the time invested. "Meta-Communication and Market Dynamics; Reflexive Interactions of Financial Markets and the Mass Media" by Thomas Schuster of the Institute for Communication and Media Studies at Leipzig University offers an excellent overview of one of our current obsessions: the role of the media in shaping price discovery and fostering irrationality.
Schuster begins by, effectively, driving a coach and horses through what is left of the Efficient Market Hypothesis - the now largely discredited theory stating that at any given time, securities prices reflect all available information. He uses by way of example the stock of a company called Entremed. "Within a year, if all goes well, the first cancer patient will be injected with two new drugs that can eradicate any type of cancer, with no obvious side effects and no drug resistance - in mice. "New drugs are said to lead to the complete eradication of tumours. The New York Times reports the story on the front page of its Sunday issue. The company holding the licence for the active substances is named: Entremed. Its stock price immediately surges by 600%.
As Schuster points out, "The news is spectacular and exciting. But it is not new. The New York Times itself had reported about the new therapy of tumours in animals in an article half a year earlier.. Financial economists are amazed by the stock price reaction to the non-event as well.. According to the efficient market hypothesis, which says that all available information is always completely reflected in prices, the republication of the story should not have provoked any significant price reactions.. But what happens in this case is exactly the opposite. The Entremed stock reacts twice: To the publication of the original news. And, much more violently, to the prominently placed re-run of the research report on the Times cover. (Other biotechnology stocks rally sharply too.) The stocks of a whole branch of industry rise, as it seems, because some newspaper journalists have repackaged already known research results a second time."
Evidently, where the efficient market hypothesis falls down is in the assumption that all market participants are equally well informed. The reality, of course, is that some investors are better informed than others, and that some investors are simply brighter than others, and/or better at rapidly interpreting new information. Yet, from a rational perspective, it would have been legitimate trading behaviour to participate in the rally in Entremed stock even if one knew that the second article represented old news: if somebody is doling out free dollar bills, it seems churlish not to participate in the largesse. And this is where hedge funds often get tarred as simplistic short-term transactional junkies.
Several journalists have suggested that hedge funds participated "recklessly" in the technology bubble by riding internet stocks all the way up and then exiting close to the top. Well, why not? Exploiting the momentum of irrationally overpriced stocks (Google, anybody?) is not a crime, though it does require steely nerves and a tight risk management discipline. By the same token, plenty of traditional fund managers participated in the mania and rode the same stocks all the way back down again.
(Article continues below)Advertisement
The narrow example of internet stock momentum trading merely serves to demonstrate that unconstrained investing, i.e. pragmatically adopting momentum-based strategies to complement other investment approaches, is self-evidently superior to constrained investing, or what one might call the practices of dumb money. In his autobiographical work of the same name ("Dumb money: adventures of a day trader"), Joey Anuff with Gary Wolf writes about exploiting the daytime programming schedule of CNBC: "Another good CNBC play was to check the CNBC website and write down the schedule of CEO appearances. You lined up their companies in your trading windows, and as each executive came on you went short. The CEO appearance was, dollar for dollar, the most reliable non-news event the stock market had to offer, because hope sprang eternal among the inside-angle-searching E*Traders, who usually managed to convince themselves that Mr. CEO, the head of some company they'd been foolhardily accumulating for months, was finally ready to announce a gigantic buyout, or earth-shattering earnings, or a mega-investment-cum-beatification courtesy of Pope Gates.
“Reliably, this did not happen. Important news was never released by surprise in CNBC interviews with CEOs, at least never when I was watching. Instead, the boss repeated old news, joked lamely with the interviewer, and answered "hard" questions with the exact same sentence the company had been using for weeks. The E*Tards, who had grabbed just a bit more stock in anticipation of the televised chat, quickly reconsidered their strategy. In other words, they bailed. A little bailing led to a little more bailing, and in the few minutes before the market recovered there were usually a few pieces of bacon available for snarfing by the cynics in the crowd."
Or to put it another way, there's always a fool in the market and if you don't know who it is, it's you. And as Schuster points out, "The media select, they interpret, they emotionalize and they create facts.. The media not only reduce reality by lowering information density. They focus reality by accumulating information where "actually" none exists.. A typical stock market report looks like this: Stock X increased because.. Index Y crashed due to.. Prices Z continue to rise after.. Most of these explanations are post-hoc rationalizations.. An artificial logic is created, based on a simplistic understanding of the markets, which implies that there are simple explanations for most price movements; that price movements follow rules which then lead to systematic patterns; and of course that the news disseminated by the media decisively contribute to the emergence of price movements."
And as Oscar Wilde once said, the truth is rarely pure and never simple. Schuster's piece is not new; the original draft was published in July 2003. But its consideration of the role of the media in the market is fascinating and largely timeless, and will likely leave readers with a little more doubt as to the value of much of what passes as informed comment, or simply as "news". Trying to finesse media reportage into profit - now there's another story.Tim PricSenior Investment StrategisAnsbacher & Co Ltd
FREE! For all our latest advice on making profitable investments, claim your 3-week FREE trial of the MoneyWeek website and magazine now.
Money Morning is the FREE daily email from MoneyWeek
– a punchy round-up of the latest investment news and profit opportunities.
DON’T MISS IT!
