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This circular extends this fundamental point. It shows why I take at face value little of what I read in newspapers and magazines, why I accept without careful consideration even less of what I hear on radio and television. (I also run as fast as my legs can carry me from “tips” and never visit investment chat sites on the Internet; but that is another matter for another circular). This circular’s purpose is not to cast aspersions upon journalists; rather, it is to emphasise that in one key respect value investors are “contrarians”: unlike virtually all other market participants, they eschew woolly words, warm rhetoric and short-term price movements, and embrace hard logic, cold figures and the long term compounding of capital. They therefore conduct their own analyses, think for themselves and keep their own counsel.
I Herd It Through the Grape Vine
To understand this stance, note first something which common sense tells us and which psychologists’ research confirms: individuals’ attitudes and behaviour tend in many important ways to conform to those of the group(s) to which they consider themselves to belong. Further, people’s deference to the other members of that group can be most marked in those circumstances in which they are uncertain or confused about the best course of action to undertake.
Note as well one of the key insights of behavioural finance (a relatively new and fascinating field of study which draws insights in approximately equal measure from both economics and psychology). As shown by its leading scholars such as Daniel Kahneman, Richard Thaler and the late Amos Tversky, money, finance and investing figure prominently among those things which render individuals uncertain, anxious and confused. Indeed, behavioural finance demonstrates that many otherwise-sensible people repeatedly make foolish financial choices. This very point inspires Why Smart People Make Big Money Mistakes and How to Correct Them: Lessons from the New Science of Behavioral Economics, an excellent book written for a general audience by Gary Belsky and Thomas Gilovich.
From these two starting points emerge two corollaries. First, individual conformity to group standards is often a good thing. Indeed, it helps to explain why individuals organise themselves into groups and why communities usually interact peacefully. If people refused to abide by any standard of behaviour, then it would be impossible to drive a car without a significant probability of collision with other vehicles, maintain mutually-beneficial systems of values such as voluntary exchange and the common law – or even hold an intelligible conversation. Clearly, then, substantial conformity to group norms, conventions and traditions has its place.
Secondly, however, problems arise when this conformity comes at the cost of individual self-interest, i.e., when we allow peer pressure either to steer us away from a course of action which would benefit us or towards a decision which does not benefit us. And because the desire to conform to group norms is greatest when the individual is unsure of himself, any alternative which is seemingly endorsed by the group will – particularly during a time of anxiety or crisis – be appealing. When you are unsure what to do, in other words, the fact that many people have adopted a particular course of action becomes a compelling reason to follow them. Hence the greater the uncertainty and the higher the stakes involved, the more vulnerable people become to a herd mentality; and given the uncertainty and anxiety which they often cause, it is not surprising that money, finance and investing can render people prone to a herd mentality and herd behaviour.
Mass Media Pitch an Undifferentiated Message to a Conformist Audience
The economic characteristics of mass media can unwittingly create and intensify herd thinking and action. In 1929, American economist Harold Hotelling demonstrated that under certain specific conditions firms in industries with few competitors will minimise the differences between their and their competitors’ products. They will also strive to cater to the tastes of the average consumer.
One must be careful not to press Hotelling’s reasoning too far: oligopoly per se has not been shown to decrease the extent of product differentiation. At the same time, however, the print and broadcast media industries approximate Hotelling’s conditions; and it has been repeatedly observed that mass media in an unfettered market tend to supply a relatively undifferentiated product which is aimed at the average reader, listener and viewer.
Assume as an example that the newspaper market can be conceived as a continuum ranging from the “shameless-scandal-mongering-gutter-tabloid” at one end to the “authoritative-highbrow-broadsheet” at the other. Assume as well that
- the cost of producing the newspaper is much the same regardless of its position on the continuum; consumers’ preferences are distributed uniformly across the continuum; newspapers are profit-maximising businesses, and in order to increase their profit they wish to attract as many readers as possible;
- each reader will choose to read that paper which most closely approximates his preference on the continuum.
Under these conditions, if there are (say) two newspapers in a city, both will position themselves at the middle (median point) of the continuum. Each, in other words, will publish a paper which is hardly distinguishable from its competitor – -indeed, the only differences will be such things as editorials which are ignored by most readers. If either paper deviates from this “median” strategy, it risks allowing the other to capture a lion’s share of the market. And if for some reason the number of papers in the city increases, then each will position itself at the median of the distribution. Similar economic reasoning can be applied to the radio and television broadcasting industries. As a result, competing mass media outlets will tend to publish and broadcast similar, relatively homogenous and basically undifferentiated fare.
Two Inherent Biases
In addition to relative homogeneity, the structural characteristics of the mass media predispose journalists – whatever their personal predilections and ethical standards – towards two particular biases. (These biases should not be interpreted as criticisms. Quite the contrary: they exist as a consequence of the fact that by definition mass media attempt to cater to the tastes and preferences of the average reader, listener and viewer).
The Short-Term Focus
If they seek to attract and retain the median reader, viewer and listener, mass media outlets will not attempt to differentiate themselves on the basis of content. With respect to news, for example, they will not generally strive to broadcast or publish the most news. Instead, to give people an incentive to buy a paper every day or listen to news reports as often as possible (thereby maximising the impact of advertising), they will attempt to minimise repetition of news content from one edition to the next. They do so by producing the most up-to-date news. The day’s events tend therefore to be presented with an emphasis on their timeliness, i.e., with relatively little long-term perspective.
More generally, news published or broadcast through mass media outlets tends to consist in disconnected events rather than inter-related issues and processes; in quotes and anecdotes rather than patterns of data; in immediate consequences rather than long-term considerations; in shock, outrage, scares and the assignment of blame rather than the assessment of evidence, reasoning, opportunity costs and benefits; in concrete words and actions rather than abstract ideas; in the ephemeral rather than the perennial; and in categorical (“good v. bad”) choices rather than incremental (“marginally better v. marginally worse”) trade-offs. As a consequence of its structure, in other words (and although exceptions will undoubtedly exist), mass media will tend to attenuate the communication of the risks and trade-offs – and therefore of the long-term costs and benefits – which inhere in various alternate courses of action.
Given the tastes and preferences of their audience, then, mass media will not seek to communicate the essence of investment decision-making. Instead, their focus on transitory events will reinforce individuals’ psychological tendency to weight the short-term too heavily and the long-term too lightly. Simply by reporting events as soon as they happen, emphasising the short term and speaking with an undifferentiated voice, the mass media can unwittingly exacerbate Mr Market’s moods. When he is in an exuberant frame of mind, talk of “hot stocks” and “hot sectors” fills column-inches and airwaves; and when he is in a despondent mood, talk turns to “market meltdowns” and “bloodbaths.” And by their very appearance in the news, minor and perhaps chance events are treated as if they were significant phenomena. If the price of a stock drops by $0.30 to $8.00, for example, it is “plunging”; and if it rises by $0.30 to $8.30 it is “surging.” The media, together with the psychological tendency of many market participants to follow the herd, can therefore cause the prices of some securities to rise to levels beyond those justified by their fundamentals. It can also drive the prices of other securities to levels below their intrinsic value. In that latter sense, perversely enough, at certain points in time the mass media are the value investor’s best friends.
...continued in Part II
 
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