Should investors take heed of economic and market news when stocks are tumbling, or are media outlets inherently fear mongering and unreliable?
Many market analysts warn we are on the brink of another recession. Despite this, however, such fears are often overblown relative to economic fundamentals, and not every anticipated recession ends up materialising. So, how much trust can we place in these media warnings? This piece argues that investors must remain mindful of a number of factors including reliability of data, over-optimistic claims, and manipulation, all of which heighten the power of the media.
Lack of data can intensify media impact
Today, one of the most often cited reasons for market turmoil by economists is doubt about China’s economic growth. In particular, analysts appear torn as to whether Beijing will be able to realise its so-called “soft landing”, whereby economic growth slows, instead of contracts, while the country transitions away from industry into services.
It does not help, of course, that official Chinese data is highly questionable. According to a Hong Kong-based investment analyst, China’s “growth data is overstated, particularly at the moment… It’s a political gesture: they have to keep the domestic markets believing that growth is roughly close to 7%.” In fact, some suggest China’s real growth is less than half the 6.9 per cent officially recorded late last year.
This has a particular effect on investors: without reliable information at hand, many become prone to react to market dips and media scares. So, data reliability can heighten the power of the media to steer markets, particularly when investors cannot draw on reliable information to make sound financial calls.
Over-optimistic can be manipulative or counterproductive
In addition to China, the media also feverishly followed the Fed and decisions to raise US interest rates. For market observers, any rate hike would be seen as an important indicator of the Fed’s assessment of US economic health. Like the Chinese governments’ official growth rate, though, such rate hikes and statements coming from the Fed are also prone to manipulation and over-optimism.
Central banks aim to instill economic confidence; indeed, in most countries their modus operandi is to keep inflation near a set target rate and provide economic stability generally. In the case of Fed, interest rates at or close to 0 per cent, combined with successive rounds of Quantitative Easing, mean it now has few policy options to left to draw on.
One remaining option, however, is try and convince everyone that, despite the Fed’s decreasing influence over fiscal outcomes generally, the US economy is still in solid shape. If consumers and investors anticipate higher inflation and better economic fundamentals, the thinking goes, this may create self-fulfilling prophecy, with market sentiment driving better economic outcomes overall.
Fed Chair Janet Yellen, for instance, has made frequent statements to the media in a bid reinforce a positive outlook on the US economy – even when such assertions fly in the face of conventional wisdom or economic fundamentals.
This means such messages ring hollow. There is a “cry wolf” effect to this, and since it leaves investors looking elsewhere for insights and distrusting the over-optimism, news reports of flagging growth and stock market death spirals have greater impact. In fact, in a recent paper, some of Wall Street’s most prominent economists warned that Yellen’s posturing on specific issues risks hurting the Fed’s credibility.
To a certain extent they are right: the Fed’s outlook has increasingly been odds with the market. Traders are no longer heeding the Fed’s statements, with many choosing to price in economic headwinds rather than rely on what they perceive to be an overly optimistic Fed. If the market is right, then the reputation and reliability of the Fed is likely to be even further tarnished.
Where to look for verification?
A dip in financial markets is frequently related to deteriorating economic fundamentals, although this is not a necessary condition. Part of the explanation for the stock market carnage so far in 2016 is a correction from a very high level (high P/E ratios for example). But some of it might also be attributable to deteriorating economic conditions, too. Yogi Berra famously noted how tough it is to make predictions, especially about the future, and that goes for economists as well. However, some of the indicators, economists watch (where available) include:
- A sudden, sharp drop in consumer confidence
- A decline in aggregate hours worked on a month-on-month basis
- A significant year-over-year increase in new claims for unemployment
- A decline in shipment activity
- Disappointing earnings reports for a wide range of businesses besides energy
- Disappointing new orders, sales, and increasing inventories
- Decreasing capacity utilization
The more of these you observe together, the stronger the signal.
How much faith should investors place in the media?
The role of financial news differs substantially, depending on your investing horizon. Panic-inducing headlines should seldom concern the well-diversified, long-term investor. There is a well-documented “Equity Premium”, meaning that in the long run, investors earn disproportionately higher returns with a (well-diversified) stock portfolio. Of course, since volatility creates opportunity there is money to be made in sell-offs. However, peaks and troughs are notoriously hard to determine, even for seasoned professionals, and whether the payoff is worth the risk and effort really depends on transaction costs, investor appetite and risk-willingness.
The bottom line, however, is that headlines alone should not act as motivation for buying or selling. Checking the underlying stats and company or market fundamentals is part and parcel of a sensible strategy.
