For Market Volatility, Blame (or Credit) the Media and the Internet

I barely trust established sources of information. I have a hard time finding [Wikipedia], an encyclopedia that anyone can alter, to be a safe way to learn anything except how many idiots think their opinions are a suitable substitute for facts. – Randy K. Milholland.

Events – and stock prices – are moving fast, so by the time you read this, Lehman Brothers (LEH) may already have gone under. Or it may have been rescued. Or it may be in rude health. Well, probably not the last outcome, no. Either way, the chances are we will all hear about it through the financial media. As Bloomberg’s Michael Lewis points out, in the fifteen minutes after that news service reported an unidentified employee as saying that his firm had failed to raise capital from the Koreans, Lehman shares had lost almost half their value. Of course, half of almost nothing is still almost nothing. And as Michael Lewis also points out, the bigger lesson here is that Asian banks, like the rest of us, should never buy anything that an American investment banker is selling.

The role of the financial media during the current market black comedy has been under-examined. It may transpire that a global reportage platform operating at internet speed has exacerbated the worst of the problems – certainly, it has accelerated the speed at which bad news skirts the globe while more positive interpretations (if any) struggle to get their boots on.

Shares in United Airlines (UAUA) were thrown to the dogs earlier this week after a six-year-old story on the company’s 2002 bankruptcy filing resurfaced via a Google search and an investment newsletter. UAL stock plumbed a low of $3 but rebounded to close the day at $10.92.

This is only really a variation, albeit in real life, upon one of our favourite quotations. Douglas Wilson wrote as follows:

We are told, ad nauseam, that a computer has to go into every classroom to prepare us for the twenty-first century. We have not yet realized that the computers may simply be moving our ignorance around the planet at incredible rates of speed. As one wag put it, “We used to think that a million monkeys typing away at a million keyboards could produce the complete works of Shakespeare. Now, thanks to the Internet, we know that this is not the case.” A fool in the back of a cart bumping along the road five hundred years ago is, today, a fool in the backseat of a Lexus. Certain things are not changed by the computer dashboard.

Not only do financial news media shuttle ignorance around the planet at incredible rates of speed, but the same computers on which we read the stories are, in many cases, the mechanisms through which we choose to transact our resultant nervousness to the dubious benefit of our portfolios. Real panic, in real time. Given the current market environment (hell, for want of a more extensive coinage), the attractiveness of a degree of grit in this machine is surely obvious.

And we have been here before. Thomas Schuster of the Institute for Communication and Media Studies at Leipzig University* has offered an excellent overview of the role of the media in shaping price discovery and fostering irrationality. One of the more dismal and now thoroughly discredited beliefs associated with the Efficient Market Hypothesis¹ states that at any given time, securities prices reflect all available information. By way of example, Schuster cites the stock of a company called Entremed (ENMD):

“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.

These days, nailing the efficient markets theory is admittedly like shooting dead fish in a very small barrel. But it is, of course, absurd to believe that all market participants are equally well informed. One might just as well say that all market participants are equally intelligent. The reality has to be that some investors are more equal than others, and some are certainly better at rapidly interpreting “new” or genuinely new information.

But there is a further point to make. Some investors also have to be better at knowing or surmising when not to act upon “new” information that might simply be noise.

A further subtlety is that it would have been wholly legitimate trading behaviour to participate in the rally in Entremed stock even if one knew full well that the second article represented old news: If somebody is offering the potential to scoop up free dollar bills effectively provided by less informed (or other trend-following) investors, it seems churlish not to participate in the largesse. Exploiting the momentum of irrationally overpriced stocks is not a crime.

Schuster’s criticism of mainstream reportage doesn’t pull many punches:

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.

There is a message here. In hugely volatile markets, where both information flow and the inventory of investor intelligence amassed between market participants are wildly asymmetrical, avoid giving undue attention to somebody’s (and for that matter anybody’s) wholly subjective (and possibly conflicted) interpretation of “the facts”.

Wilde had it right: the truth is rarely pure and never simple.

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*”Meta-Communication and Market Dynamics; Reflexive Interactions of Financial Markets and the Mass Media”.

¹The acronym for which should, by rights, be C.R.A.P.

Comments

[BxCapricorn:]

I liked the piece,but nothing said about hedge funds? The average investor cannot move the market. The little guy merely follows the computer trading programs employed by quant funds, hedge funds, etc. which are responding to the financial media's story or theme over a selected time frame. The "little guy" is playing in a rigged casino that is today's stock market, which is made even worse by the incessant flip-flopping of stock gurus.

2008 Sep 12 03:45 PM

[Tim Price:]

I respectfully disagree. There is a fascinating interview on Bloomberg between Tom Keene (if memory serves) and David Goldman of Asteri Capital. Mr Goldman suggests that hedge funds that report on a monthly basis (and that offer their investors regular liquidity) are facing a potential catastrophe of serial liquidation. There are too many crowded trades out there and many hedge funds are sufficiently flimsy in orientation and structure that they can get taken out on a malign tide of redemptions. The "little guy" doesn't have to report to external investors and can more easily weather extreme volatility in price variation. Right now, I think the "little guy" is very well positioned in these markets - provided he or she has the emotional discipline not to panic at noisy price action that moves against them.

2008 Sep 12 04:39 PM

[Alan von Al...:]

Tim, you're a thoughtful guy and wonderful writer. Strong thesis, with two faults. In days of Gould and Fisk, newspaper editors and slander drove hysterical, spiralling trades. But more importantly, today as well as a century ago, "demand" has a very specific economic meaning: how much cash or credit you have and are willing to pay out for something (shares or option contracts or bonds). I wouldn't dismiss or denigrate decentralized global interactive news and opinion. It helps discover and mitigate the "weight of money" conundrum, where bulge bracket entities are hamstrung for fear of moving too much money.

2008 Sep 12 09:47 PM

[trikerguy:]

While you didn't cover all aspects of what moves markets (and your piece didn't have that intention), I wholly agree that media has its agenda - sell more advertising or support the political/economic views of its stakeholders . Therefore, it often gives "facts" that are sperious. The net goes further. Posters require no substantiation. So in both cases I consider the sources flawed unless the author has a proven track record.

2008 Sep 13 11:47 AM

[henarl:]

Except in the very long term, actual facts (if there really are such things) have very little effect on the markets. Perceptions are what count and the astute investor (if there really is such a thing) acts upon his perception of what other people's perceptions will be.

2008 Sep 13 03:06 PM