Should You Give Up the News?
How much news do you consume daily?
And how much of it is useful?
Take Joe, an avid investor.
His morning routine involves caffeine, a copy of the Australian Financial Review, and his iPhone on standby.
After he scans the paper, he switches to his phone, flicking between the regular culprits — the Wall Street Journal, CNBC, The Economist, Bloomberg, Barron’s…even Cointelegraph gets a cursory look.
And then there’s Twitter.
Joe follows hundreds of accounts — commentators, analysts, economists…he scrolls through their many tweets, liking one here and there.
But Joe always feels like he can be reading more — that he’s always missing a news item. News that will make all the difference for his investments.
If only he just reads one more tweet, scans one more headline…
But is that true?
How much of Joe’s reading is simply noise?
Noise and signals
Economist Fischer Black — co-author of the Black–Scholes equation — wrote an interesting piece on noise in financial markets all the way back in 1986.
In his paper, Black distinguished between noise and information, writing:
‘Noise trading is trading on noise as if it were information. People who trade on noise are willing to trade even though from an objective point of view they would be better off not trading. Perhaps they think the noise they are trading on is information. Or perhaps they just like to trade.
‘With a lot of noise traders in the market, it now pays for those with information to trade. It even pays for people to seek out costly information which they will then trade on. Most of the time, the noise traders as a group will lose money by trading, while the information traders as a group will make money.’
How much of what we read is noise — and how much is information?
News — especially in finance — operates at warp speed.
A topic that may require time to examine and analyse properly is given short shrift by harried journalists pushed to publish.
Often, the news we read is surface level. We seek context and insight but often find disjointed data points.
I’d add a further distinction to Fischer’s conception of noise.
Noise contrasts with information. But information also contrasts with insight.
Sources like Reuters and Bloomberg can give you one — but not necessarily the other.
Insight is harder to come by…and involves more active participation on our part than passive headline scanning.
As James Valentine, a top equity analyst, noted in his book on best practices for equity research: don’t mistake news for research.
Valentine also relayed advice he received from a hedge fund manager:
‘If you chase all of the news flow and data points, you may miss the critical data that will actually drive a stock.’
News can help us make sense of the world — but making sense of the world is not always the same as understanding it.
What do you think would happen to your investment skill if you quit news for six months and read the classics of the finance genre instead?
Would you come out of the six months worse or better off?
Of course, you can’t go without news forever. To have insight, you need information as feedstock. But how much information you need is a good question.
Investing and the 80/20 rule
You have likely heard of the 80/20 rule. The rule posits that for many outcomes, 80% of the consequences stem from 20% of the causes.
The rule is often attributed to Italian economist Vilfredo Pareto, who observed that more than 80% of Italy’s wealth belonged to 20% of the population.
You can spot the rule in many places.
In business, it’s often said 80% of sales come from 20% of clients.
In software engineering, a Microsoft study found 20% of software bugs cause 80% of all errors.
And in sport, where 20% of the players enjoy 80% of the success and prize money.
James Valentine thinks the 80/20 rule is applicable to investing, too. Specifically, the rule applies to your information flow.
‘As a general rule, 80% of alpha-generating insights come from 20% (or less) of the available information flow – focus on the sources that traditionally yield insights. Sounds like common sense, but this can only be achieved by proactively turning off as much of the 80% unproductive information flow (ask yourself, what can you turn off today?)’
Valentine then elaborated on what to be mindful of when it comes to news (emphasis added):
‘While the news may be interesting and provide new data points, it doesn’t forecast the future, which is the job of an equity analyst. You can waste a lot of time reading stories that don’t help pick stocks.
‘Second, the financial press will often follow a herd mentality by having a party when the Dow Jones Industrial Average hits new levels and predicting the next Great Depression when the market hits a near-term low. Don’t look for the press to take an out-of-consensus money-making stance, a position your employer expects of you.
‘Third, the press does not always take an objective view toward the subject at hand because its primary motive is to increase readership or viewership (and thus advertising dollars). Learn to appreciate this difference because the press will often inflate an issue’s importance or explore an angle of the story that has less investment significance than another, simply to attract more eyeballs.’
The point about the media’s herd mentality is worth highlighting.
Much of market outperformance rests on determining where the consensus is wrong.
‘If you want to give yourself an edge in investment markets, you have to think the opposite of what others are thinking.
‘Or explore places no one is thinking about at all!’
You won’t beat the market by following the market. And you won’t generate insight simply by following the news.
For Money Morning