Stop the Noise

Jim Parker of DFA offers an interesting anecdote about how the financial press and the press in general spin the facts to meet the story that has occurred. If you look hard enough, you can find examples of this type of "analysis" through out the various US media sources commenting on why the market has acted a certain way in response to news.

October 2009

From Cacophony to Symphony

Jim Parker, Regional Director, DFA Australia Limited

Sometimes it's hard to make sense of day-to-day noise in stock prices, particularly when news is thin on the ground. But that doesn't stop lots of people from trying to discern predictable patterns in the racket.

Building coherent narratives out of random stock price moves, often under the pressure of constant deadlines is the job of journalists and research analysts. The most successful ones make it all seem perfectly rational and predictable.

This ability to communicate the idea that 'this happened in the market because that happened' is most brilliantly demonstrated when circumstances change two or three times in the space of a day or two.

Let's take a look at a recent example. In the week beginning October 5, the media reported that markets were anxiously awaiting a policy meeting that week of the Reserve Bank of Australia's board.

While there was disagreement about the timing of the move (most thought it would come in November), there was a strong feeling that the RBA was on the brink of raising interest rates, becoming the first 'Group of 20' central bank to do so in the wake of the global financial crisis.

On the Monday ahead of the RBA meeting, the Australian share market fell by 0.6 per cent. One journalist quoted dealers as saying there was a fear that an early rate hike could shake market confidence and curb the recovery.¹

Sure enough, newspapers on the morning of the bank's meeting were full of dire warnings of what would happen to asset markets if the Australian central bank broke from the pack and started to withdraw stimulus too early.²

As it turned out, the RBA did raise its cash rate that day, by a quarter of a percentage point to 3.25 per cent, and a month earlier than most expected.

And what did the Australian market do? It closed higher. The benchmark S&P/ASX 200 index ended up 0.4 per cent, albeit off its intraday peak. According to an analyst quoted by Dow Jones, the rate rise could actually be seen as confirmation of the strength and resilience of the Aussie economy.

But the story didn't end there. Not only did the RBA's "surprise" rate move fail to derail the Australian market, it actually triggered a global rally. The Wall Street Journal: "A surprise interest rate increase in Australia reignited confidence that the global economy is recovering from recession, sparking stock market rallies around the world and lifting gold prices to record highs."³

You see how these rolling interpretations work? You keep changing the narrative to suit the changing circumstances. The trick is to make it all seem perfectly obvious after the fact. "This happened because that happened."

The fact is stock prices move for all sorts of reasons, and trying to provide neat and immediate explanations is a treacherous business for young players. Sometimes a price changes because of news related to the individual stock. But even then, just as with economic news, the reaction is not always what the media say it will be, usually because the market has already priced it in and is looking one step ahead.

Back in mid-September, the Australian government created a stir when it announced that it would force the nation's largest phone company, Telstra, to split into separate wholesale and retail businesses.

On the day of the announcement, Telstra shares slid more than 5 per cent. The government's break-up order, according to one wire service report⁴, represented a "giant kick in the teeth" for the company's shareholders.

The next day, though, the story changed. Telstra shares regained all of their losses. Analysts had now reviewed the break-up plan and decided it would help position Telstra to secure part of a lucrative national broadband deal.⁵

So the narrative of why stock prices rise and fall on any day changes because new information is always coming into the market. No sooner has the journalist carefully crafted a water-tight story out of one development, than something else happens and the whole edifice springs a leak.

Stocks often move because of investors' views of equities as an asset class, not for any reason related to the individual stock. The market may move higher or lower and individual stocks will shift up and down by a certain amount in sympathy, depending on how sensitive they are to market risk.

Stock prices also can move for apparently no reason at all, or at least for no reason that the media takes notice of. It could be because a large institution is liquidating a portfolio or because of arbitrage activity between the physical and futures market or because of options expiries. It may just be because someone is selling a large parcel of one stock to fund a purchase of something else. None of this is particularly interesting or significant in the big scheme of things. It's like watching rush-hour traffic.

The bad news for harried journalists and market analysts is that they have to try and orchestrate all the random noise that constitutes messy day-to-day reality into a fascinating, elegant and seemingly pre-ordained symphony. And every day, they have to start all over again.

The good news for the rest of us is that there is no compunction to listen.

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¹'Australian shares fall 0.6%, banks skid on rate talk', Reuters, Oct 5, 2009

²'Housing disaster looms if rates rise', The Australian, Oct 5, 2009

³'Australian rate rise spurs stock, commodity rallies,' The Wall Street Journal, Oct 7, 2009

⁴'Shareholders say not one good thing in Telstra proposal', Australian Associated Press, Sept 15, 2009

⁵'Australian shares up 2.4%, banks surge', Reuters, Sept 16, 2009

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