Be Careful What You Believe

At some point in time during most of our childhoods, we may have been told by a parent there's a fairy who will gladly trade a dollar or two for any of our baby teeth we leave under our pillow. Of course when you're five years old, the absurdity of it is trumped by the possibility of it being true - as there could be some cash involved.

At some point though, reality takes over and we all realize there's really no such thing as a tooth fairy. In fact, at the age of eight or so, all of life's really fun mysteries are washed away as we become smart enough - and experienced enough - to recognize truth from fiction. In other words, we know what to believe and not believe.

However, I wonder how many traders still believe all the broad market and economic news they hear, read, or see from the financial media machine. It's not hard to do - as a geopolitical society (and for the most part, a global society), we've been told repeatedly the media is trustworthy, unbiased, and complete in their message. By the time we reach the age of majority, we've been basically trained to accept whatever it is we're being hand-fed by the print and electronic media institutions.

Mixed Messages

While I have no intention of opening up the 'is the media biased?' argument, I do think it's worth examining whether or not most financial reporting is actually helpful to individual investors. I contend that it's not...at least not for the most part. That's not a stab at anyone's standard of ethics - it seems as if most financial journalism is a fierce search for factual truth. Rather, it's just a question of whether or not the financial newspapers, magazines, websites, and television shows that try and deliver infinite news - mostly economic - are of any real benefit to those who follow them.

As just one illustration, consider these recent, unedited headlines taken straight from the Yahoo Finance home page.

Early on December 19th, 2006, this headline appeared: "Stocks Slip on Inflation Worries". Later on the same day, this headline popped up on the very same page: "Dow Hits Record High Despite PPI Report".

Sooooo.....does inflation have an effect on stocks or not? The first headline makes it seem as if inflation concerns are bearish. The second headline makes you wonder if the inflation data is irrelevant. Were both headlines factual? In a sense, yes - stocks were lower in the morning, but higher in the afternoon. However, the reasoning may have been off the mark. Either inflation is a non-issue, and shouldn't have been cited in either headline. Or, inflation doesn't necessarily drive stocks lower, meaning the cause-effect shouldn't have been cited in the first headline.

Again, it's not an accusation that the AP (they provided the articles and headlines) was acting improperly. However, an investor searching for help that day may have grappled with a very conflicted message.

Another noteworthy example....in August of 2006, we learned the Conference Board's Consumer Confidence Index had fallen to 99.6 - the lowest reading in nine months (and had it not been for the post-Katrina pessimism, it would have been the lowest reading in a couple of years).

A reason for investors to bail out of stocks? According to the 'experts', you'd think so. James Knightley, an economist with ING, wrote "Lead indicators suggest little prospect of a turnaround anytime soon....Confidence is likely to remain under downward pressure." Economist Ian Shepherdson just responded with "Ouch."

If an investor had taken those comments to heart and sold his or her stocks, he or she would have ended up missing the S&P 500's 8.8% gain over the next four months. Clearly, August's dismal confidence level didn't drag stocks into the gutter - quite the opposite actually.

The challenge is, we see and hear these kinds of confusing messages all day long.

Defining the Two Key Hurdles

The examples above were specific, but both fit within the framework of two general financial reporting challenges I see investors dealing with on an almost-daily basis.

Problem # 1: There's no continuity - only 'right here and right now' matters

Trends are far more important to investors than individual data nuggets are. Unfortunately, covering trends can take up precious space and time. Journalists - whether on paper or on television - have to get through data quickly, since 'more is better' (at least in the eyes of the media moguls). So, you'll not get much more than this month's, week's, or quarter's information before you're whisked off to the next topic.

I've observed unemployment trends to be particularly poorly reviewed by journalists. That's too bad too, since the unemployment figure actually has a pretty solid (and predictive) correlation with the stock market. What you might normally get is last month's reading, and whether or not it was above or below the general expectation. What I think you should get is several month's worth of changes.

To illustrate the point, ask yourself what you would do if you learned the unemployment rate was 4.9% (considerably less than the long-term average of 5.8%). Is it good news for the market?

Your first thought might be, yes, that's a sign of economic strength, and should be good for stocks. And, in May of 1997 you would have been right - the S&P 500 closed up by 28.5% a year later. But, when unemployment was 4.9% in August of 2001 you would have been wrong - the market was lower by 19.1% a year later.

What was the missing piece of the unemployment puzzle that could have provided some much needed insight? The trend at the time. In 2001, the unemployment rate was sky-rocketing. In 1997, it was dropping like a rock. Anybody could have made the right call, if only there was a little continuity and context in the way the data was reported.

Problem # 2: Information is treated as if a future consequence is a foregone conclusion

I'll be the first to acknowledge some data is very important, and should be treated accordingly. I'll also be the first to say most 'economic data' is pointless for investors to process. Notice that I didn't say it was meaningless - just pointless to follow. The Gross Domestic Product (or GDP) is one such data nugget. By the time you get the quarterly data, you're several weeks into the next quarter. Even worse, the data is reflective of information that goes back as far as three months before the prior quarter ended. I believe by that point, the good or bad effect of whatever it is the GDP actually indicates is already priced into stocks. Yet, you can always count on somebody making some sort of market call based on the latest batch of GDP data.

Solutions

So what do you do? There are three specific things I think could help you right away. None are easy, and all could take a little practice. However, I also feel it's worth it.

Solution # 1: Train yourself to weed out everything that's irrelevant (which frankly is the majority of the messages you're bombarded with). You don't have to avoid the news altogether; we study the news quite consistently. However, you do have to limit which data you mentally process. Regular readers of our site will know we try to strip away all the external fluff and get down to the important data. Specifically, that's earnings progress, future potential for revenue, and our feel for the market's current and future opinion of a stock.

Solution # 2: Provide your own continuity. The financial media certainly won't do this for you, as we examined a moment ago. So, it's up to you keep track of your own data trends - or at least use the means you have at your disposal to discover those trends.

In terms of an individual stock, this might mean you have to dig back through a few years worth of SEC filings to get the complete picture...something we tend to do as part of our due diligence process. However, it's time well spent. One poor quarter for a company might be detailed for a fleeting moment on a news cast, then forgotten. However, it's very unlikely you'll learn from the same news broadcast that a company has actually seen earnings shrink for twelve consecutive quarters. We can overlook one bad quarter, but three years worth of troubled results is the kind of thing we think is best avoided. You'll probably have to find it out on your own though.

Again, that's the kind of digging we usually do around here.

Solution # 3: Lastly, and in an all-encompassing way....be skeptical. This isn't the same as being blindly critical - lots of information can be, and is, useful to investors. But, just because you read it in the newspaper or see it on television doesn't make it helpful (or even relevant) advice. That's one of the things we try to always do with this site - provide context we know to be factual as well as meaningful, and offer a logic-based rationale for our opinions, rather than just hopes and dreams.

I sincerely believe anyone can beat the market by just figuring out which news really matters, what the information really means, and whether or not there's an evident trend. In my experience, the direction journalists might point you isn't necessarily the right one. Think critically, and don't feel like you have to respond to everything you hear.