How much attention should you really pay to the news?
How much attention should you really pay to the news?
News can be raw sustenance for market participants—and 2022 has had more than its fair share of market-moving events. But can anyone truly rely on news to make sound investment decisions?
It would be naïve to deny that in the new age of information, news has been absorbed into the massive content invasion that has permeated our society. Now it is just one component of a deluge of information designed to capture our attention, provoke our emotions, entertain us, prompt us to purchase things, and even shape our views.
Now almost anyone can offer news or other content to the public, leading to a flood of media sources that vie for our attention. In the process, the quality of information has been diluted, making it more difficult for investors and investment or advisory professionals who rely on accurate and unbiased information.
The electronic delivery of news and information has become the essence of an entirely new business model. It’s so much easier now for people to create and distribute content to court a following that can be easily monetized. News has been thrown into an enormous melting pot of information that includes blogs, podcasts, videos, tweets, texts, and postings.
In this new world of information blur, news is often used to tease or introduce other services or attract eyeballs to sell ads, essentially obscuring the boundaries between news, opinion, advertisement, education, and entertainment. Unfortunately, what fueled this trend is our desire to have all that information in the first place, despite the challenge we have of processing it effectively.
In addition, algorithmic trading, coupled with machine learning and artificial intelligence, has become so adept at scooping the value out of news before the public can react that by the time we do respond, we are simply providing the liquidity through which the machines can exit their trades.
What is even more disconcerting is that social media often exaggerates news anticipation. Now, much of a stock’s positive price correlation with news (i.e., good news leading to higher price) actually occurs before the news is announced, leading to negative correlations immediately after the announcement.
The question for investors, advisors, and investment managers is, is it still safe to drink from the news well, or has it now become contaminated?
More and faster information is better … until everyone else has it also
Even the most ardent “efficient market” devotee will admit that a genuine technological advantage can find cracks to exploit in the market’s wall of efficiency … but only if that advantage is held by a very small number of participants. Once the advantage is widespread, all bets are off, and efficiency once again reigns. Now that everyone has more and faster information, the advantage has not only disappeared but participants are under increased pressure to use all of that information to simply remain competitive.
Another downside to having too much information is that it’s not really an advantage for human decision-making, which tends to get bogged down when required to process it into actions and decisions. Studies commonly show how consumers can balk when faced with too much choice or the need to analyze it too quickly.
Our brains are wired to make quick decisions and to take shortcuts (called “heuristics”) to do so. Heuristics are a major contributor to the many biases we exhibit when making decisions. More information leads to more shortcuts, which leads to more biased behavior and less effective analysis. Beyond a certain point of input overload, our brain machinery will actually seize up entirely and refuse to make a decision at all.
For algorithmic or high-frequency traders, the task of dealing with news is simple: They essentially ignore what it says. It’s not the actual content of the news they care about for “scalping” trades—it’s simply the reaction. A computer just has to spot the surge in volume on one side of the market, jump on it, and ride the momentum. The time horizon might be minutes or even microseconds.
If you do that frequently enough, you only need a win rate of slightly better than 50% to be successful. Ask any casino. Better yet, read Gregory Zuckerman’s book “The Man Who Solved the Market,” which is about famed mathematician James Simons and his hedge fund Renaissance Technologies. In his interview with Zuckerman, Simons admitted that his win rate was indeed only a handful of percentage points higher than 50%. And that’s all it took to produce one of the most profitable sustained performances for a hedge fund—over an impressive period.
For nearly two decades now, efforts to trade the markets using super-fast algorithms have combined with data science and machine learning to find ways in which financial news can be interpreted at lightning speed to facilitate profitable trading or investing. The effort spawned an entirely new industry of data-science experts who have developed many ways to use a computer to extract profitable trading ideas from news sources and social media.
One such company is RavenPack, headquartered in Spain. RavenPack supplies banks, asset managers, and other financial institutions throughout the world with data analytics gleaned from 40,000 news and social media sources. With this kind of firepower aimed at electronic news, the efficiency of news dissemination on market prices has undoubtedly improved far beyond the capacity of any human to find a consistent trading edge.
For, investors, advisors, and active investment managers, however, assessing news and knowing how and when to act on it is a critical element to investment success. To deal with news as a human, therefore, means dealing with three major challenges: the sources, the human brain, and the market.
Problems at the source
News sources today operate on business models that have been forced to change to compete in the new world order. Many are still struggling to adapt to the rapidly changing landscape of the technology that delivers it. Eons of change have occurred in just the last five years. Here are some important trends:
Social and political bias. News sources have become so clearly opinionated that they wear their views as a badge of honor and a competitive differentiation. There is little question to anyone now what the political leanings or social views are for sources such as Fox News, CNN, MSNBC, Newsmax, The New York Times, The Washington Post, or the Washington Examiner. Even the generally respected business resource, The Wall Street Journal, is only “trusted” by 37% of the U.S. population—with its business news rated as down the “center,” but its editorial policy seen as having a distinct leaning.
Unfortunately, news and opinion are now mixed to the point of non-distinction in many situations. The sad truth is that news is now hugely slanted by the views of the media’s owners or the writers and newscasters themselves. As such, we can no longer expect news to effectively present both sides of a story.
Placement bias. Biases extend beyond politics as well. Page placement, which confers the relative importance of news, is now biased toward what the source feels will catch our eyes and hold them on the screen, rather than on the relative importance of the content.
Pressure to sensationalize. Competitive pressures force news media to sensationalize headlines in order to stand out. In addition, sources are now more knowledgeable about our behavior, so they feed into our biases (confirmation bias, emotional sensitivity, recency bias, what we are most likely to share with others, etc.).
Questionable sources. Thousands of new sources proliferate on the internet. Some are high quality. Others are downright dangerous. The content industry has gone from being driven by educated journalists to just about anyone who can type on a keyboard.
Little accountability. There is precious little accountability on independent websites and newsletters. Misinformation has risen to an art form, and intentionally fake news abounds.
Cheap or free news is widely available. There is, however, a price for it in terms of quality, timeliness, accuracy, and completeness. Free news may be delayed or serve as a teaser to subscribe to yet another information source.
News and information are now directly targeted at our biases. That includes confirmation bias (reading about that which confirms our existing beliefs), moral bias (becoming outraged by actions we deem unfair), representativeness bias (jumping to conclusions from anecdotal data), and FOMO (the fear of missing out on something everyone appears to be doing).
Problems at the receiving end
Human biases are evolutionary in their origins, so the digital information age did not cause humans to have them. But it certainly has exacerbated them.
In May 2015, Time magazine reported on a study conducted by Microsoft involving 2,000 participants beginning in the year 2000. The study concluded that the average human attention span had decreased from 12 seconds to eight seconds. That places us just below goldfish on the attention scale.
With an attention span reduced by approximately one-third, can we reasonably expect that our decision-making apparatus has improved?
If anything, our reduced focus coupled with the additional information we now consume in the same period has put even greater pressure on our brains to cut corners. It would be great if our brains knew what information to ignore, but that’s not how we’re wired, and there is no easy way to do that anyway. If you read an analyst’s report on Twitter and then read articles about a barrage of tweets by Elon Musk criticizing Twitter’s policies/business model, how is your brain to reconcile that information?
The fact is that our brains already employ a host of shortcuts to deal with all of the information we are currently exposed to. We use availability bias to give more weight to the most recent information. We use representative bias to overweight anecdotal information. And we use herding to overweight what others are doing. All of these are ways in which the brain arbitrarily reduces the available information to something that can easily support a decision. None of these heuristics make the decision more valid or accurate.
There has long been a question of just how much news affects individual stocks or entire markets. Numerous studies have tried to address this issue, but the complications of isolating price-relevant news, weighting that relevance, distinguishing news from sentiment changes, accounting for simultaneous and often unobservable factors, and determining over what period the impact on stock price should be measured, have combined to produce a very mixed bag of results.
Early studies, such as Richard Roll’s in 1988, calculated that economic influences and firm-specific news accounted for only about 35% of the variation in monthly returns of large-cap stocks, and only 20% of the daily price variation, suggesting that news had a relatively low impact on stock returns. Roll’s conclusions ruled the day until subsequent studies zeroed in on certain types of news, such as press releases or earnings announcements, and used much shorter time frames.
A paper published by Kerssenfischer and Schmeling in April 2022 concluded that news accounted “for about 50% of all bond and stock price movements in the United States and euro area since 2002.” Their study predominantly used scheduled press releases and measured their impact inside a window of -15 minutes to +30 minutes from release.
Even if the latter study is closer to the mark, however, few financial advisors or even most investment managers, are likely to religiously analyze press releases in the first 30 minutes following release. So, the question remains: Is reading an article on the same subject hours or days later any use? Worse yet, is acting on that news counterproductive after the first 30 minutes?
Occasionally, market-moving news events are worth catching as soon as they come out, but it’s rare. And even when something does occur out of the blue, like 9/11 or the Kobe earthquake in Japan, chances are the initial announcement alone is not sufficient to warrant immediate action until a broader assessment can be made.
The evidence also shows that the relationship between news and the market is not a discreet one, but rather a smoothed effect over a period that begins with anticipation before an event occurs, builds in nature as the event unfolds, and then continues to affect the market through price momentum. Market participants know, for example, that the initial reaction to a Federal Reserve rate announcement can be very misleading, with the market often changing direction several times over the next 24-48 hours.
All of this fits perfectly well with the notion that people take time to digest the news, assess its impact, watch for the market’s reaction, gather opinions from advisors, and determine how they will subsequently act.
The bottom line on news
It may be constructive for advisors, investment managers, and investors to reevaluate their relationship with, and subsequent reactions to, today’s news and the sources from which we obtain it. We marvel at the technology that brings so much more information to our mental doorstep, but we may not actually be utilizing such information to improve our investing prowess.
It is certainly important for financial professionals—if not all investors—to stay well informed on the latest political, business, economic, and market developments. But it is equally important to recognize that short-term, news-driven investment decisions are generally not a wise course of action—especially for individual investors who may lean toward overreaction.
A recent article in this publication stated it well when discussing investors’ potential reaction to serious market pullbacks or the threat of recession—but it fundamentally applies to any consequential news story:
The opinions expressed in this article are those of the author and do not necessarily represent the views of Proactive Advisor Magazine. These opinions are presented for educational purposes only.
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Richard Lehman is the founder/CEO of Alt Investing 2.0 and an adjunct finance professor at both UC Berkeley Extension and UCLA Extension. He specializes in behavioral finance and alternative investments, and has authored three books. He has more than 30 years of experience in financial services, working for major Wall Street firms, banks, and financial-data companies.