Content provided by Rusty Vanneman, CLS Chief Investment Officer
A lot of information flows across investors’ screens these days, more information than ever before. This is the case for both individual and professional investors. Just how much of this information is important though? How much is just trivia and filler? How much of it is produced by information manufacturers with a vested interest to create a sense of urgency to act and put “money in motion?”
The reality is that much of the information we come across on a daily basis is useless (or even harmful). If the information has any relevance, is the importance in its explanatory power or its predictive abilities?
Information that is relevant to a particular investor needs to be pertinent to their time horizon. If one has a long term investment horizon, and holds positions for at least 2-3 years on average, how much of the daily news is truly useful and impactful? In this case, the data inputs that are critical aren’t the daily sensation-seeking, emotion-inducing headlines; rather, they are the gradual updates to the underlying variables that determine stock prices in the years ahead, such as earnings growth and valuations.
News, in general, attempts to be explanatory, and financial news is no different. The whole financial system benefits from explanations of market movement. There is a need to create some degree of comfort for investors to help demystify why prices went up or down. This explanation can also potentially create some confidence that future prices can be predicted, even if the news isn’t exactly accurate or oversimplifies the true driver of prices.
Information that may explain past market behavior isn’t necessarily predictive in the way many expect though. Let’s take a look at two examples. First is the unemployment rate. A high unemployment rate typically follows market corrections, as high unemployment is the result of weak economic growth. Stock prices meanwhile, are usually way ahead of the game.
It may seem intuitive to expect that a high unemployment rate means more below-average stock market returns moving forward. The predictive nature of this data is different, however, as a high unemployment rate typically precedes above-average market returns. Why? While the market is often a leading indicator of the economy, the unemployment rate is a lagging indicator. To re-state, economic news follows price action, but the markets are always looking ahead – and typically lead both the economy and news headlines.
Another example is corporate earnings growth. A stock market with strong trailing returns typically has had strong trailing earnings growth. Once the market is already displaying high earnings growth though, that tends to be predictive of below-average market returns moving forward.
The news may seem to provide some clarity, but in the end, it’s best to remember that the markets are messy, murky, and mysterious. While some may lean on quantitative methods to help cut the fog and to help provide some rigor and discipline (legitimate benefits), even mathematics can’t fully solve the riddle of market returns.
To help cut through the noise and clutter, it’s best for investors to figure out how to put the odds in their favor and just stick to the investment beliefs and inputs that they believe will put the probabilities of long-term investment success on their side. This usually includes maintaining an equity orientation, diversifying to an appropriate risk budget level, emphasizing value (the price you pay for a unit of fundamental value like earnings or dividends), keeping transaction costs at reasonable levels, and being diligent about portfolio/risk management.
Acting on the daily news is not on the list of how to keep the odds in your favor. So, how should one look at the news to make financial decisions? The best answer is not to look!
Indicators are measurable factors that could signal a change in the economy. Indicators are not always accurate. Past performance is never a guide to future results.