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A television camera, for example, can easily record the devastation wrought upon farmers by drought, flood and pestilence. It can also capture farm families’ poignant pleas for government assistance. Similarly, a print journalist can observe the closure of a factory, interview the workers who have been thrown out of work and demand compensatory government action. And a radio bulletin can announce the relief and exultation which erupts upon receipt of the word that the government will intervene.
Short-term and directly-observable costs and benefits, then, are relatively easy to record. Long-run and less-observable consequences, however – and cause-and-effect sequences more generally – are inherently more difficult and perhaps impossible to capture on tape or film. No camera, microphone or scribe can directly observe the moral hazard and dependency created by government intervention. No videotape can show the crops which would have been grown elsewhere – or the other products which would have been manufactured via other processes by other people in other places – in the absence of such intervention. And there are no means by which a journalist can identify and interview those unemployed people who would have had jobs if minimum wage laws had not made them too expensive to hire at their current levels of skill and experience.
Alas, the Media’s Conformist Message Is Prone to a Reign of Error
To sum up the argument to this point: investing can render people prone to a herd mentality and herd behaviour; the economic characteristics and structural biases of the mass media can unwittingly intensify the galloping of this herd; and at certain times the combination of these psychological and economic factors can inflate the prices of some securities to rise to levels far beyond justifiable levels. In a balanced article in The Weekend Australian of 11-12 March which drew attention to exactly this danger, author Tim Blue noted: “these days it is impossible not to hear words that suggest global technology stocks are manna from heaven; the new nirvana on which it is impossible to lose money.”
Unwittingly incomplete and exaggerated statements were staples of communication long before the rise to ubiquity of the modern mass media. And significant numbers of journalists are acutely aware of them and strive to correct them. But perhaps never before have short-term and sensationalist appearances reached so many people so constantly and with so much immediacy. In the words of John Stossel, a correspondent with the American ABC TV network: “the press obsesses about today’s news, and has an incentive to make today’s ‘scare’ a bigger story than it is; after all, the drama may sell more papers or get more people to watch a TV program.” In short, and despite some journalists’ best efforts, not only does the structure of the mass media mitigate against the communication of the fundamentals of investment decision-making: its emphasis on the graphic and sensational reinforces investors’ psychological tendency to be more receptive to short-term events than to long-term processes, trade-offs and consequences. The result is that at critical junctures the crowd can develop incomplete or inaccurate views.
It therefore comes as no surprise to learn that print and broadcast news routinely and drastically exaggerate new, exotic, visible but trivial risks, and that they underestimate pre-existing, familiar, less visible but far more profound ones. Readable books which document this point in great detail and in a variety of contexts (including business risk and investment) include James Walsh, True Odds: How Risk Affects Your Everyday Life and Barry Glassner, The Culture of Fear: Why Americans Are Afraid of the Wrong Things.
How Value Investors Consume Mass Media
A free mass media is a bulwark of a free and open society. Yet both journalists and their audience are flesh-and-blood people who are prone to eternally human foibles including exaggeration, error, fear, greed and folly. How, then, to navigate a course through the mass media minefield? I use three rules of thumb to separate the investment wheat from the media chaff.
Rule #1: Filter Out the Short-Term and Superfluous Chaff
First, I strive to ignore those media outlets, broadcasts and articles which obsess about stock prices, movements in prices, gossip, scuttlebutt and other short-term phenomena. This is because these things are almost without exception based upon emotions (typically either fear or greed) rather than logic, and upon woolly words rather than hard evidence. It is also because investors who focus on these things probably fare worse than those who filter or tune out this information. Noteworthy in this respect is the research of Paul Andreassen, a Harvard psychologist who conducted an experiment with groups of mock investors. He found that that those investors who absorbed little or no ‘news’ achieved better results than those who received and pondered a constant stream of price and other short-term information.
More generally, the best investors ignore the majority of what currently passes as important financial news. It is well-known, for example, that in past years Warren Buffett did not own a stock ticker and that today he ignores on-line price and other financial information. As Mr Buffett stated in Berkshire Hathaway’s 1993 Annual Report: “after we buy a stock, consequently, we would not be disturbed if markets closed for a year or two. We don’t need a daily quote on our 100% position in See’s or H.H. Brown [companies wholly-owned by Berkshire] to validate our well-being. Why, then, should we need a quote on our 7% interest in Coke?”
Rule #2: Focus on the Long-Term and Fundamental Wheat
Scattered and obscured among the chaff, however, are significant nuggets of wheat. Accordingly, I study those media outlets, broadcasts, articles and other materials which describe companies’ and sectors’ economic fundamentals and other long-term phenomena. It is significant that material relevant to these matters is often found in specialist rather than mass media. These include company announcements and Annual Reports, as well as industry- and government-sponsored research papers and statistics. (They do not, however, include brokers’ and commission-based advisors’ materials: as Austin Donnelly emphasises, these are actually sales and marketing material in disguise). It is equally significant that Graham, Buffett and other outstanding value investors consume and study large quantities of such materials.
The operative word is “study.” Value investors do not accept at face value the contents of what they read, hear and watch; rather, they use these materials as starting points from which to conduct their own analyses (augmented where necessary with raw data which they have located and confirmed themselves), think for themselves, draw their own conclusions and keep their own counsel. Mass and specialist media, then, provide the beginning rather than the end points of their enquiries.
Rule #3: Scan the Media for Opportunities to Be an Intelligent Contrarian
If forecasts tell us much about forecasters but little about the future, then the mass media tell us much about what is on journalists’ minds but less about what is happening and why. Accordingly, the mass media provide a foil which value investors use to check their assumptions, logic and evidence against the conventional wisdom – and to judge when ignoring the crowd and acting upon one’s own convictions is rational and appropriate.
The phrase “regression to the mean” refers to a pattern among observations which are made repeatedly over time. Consider as an example a student’s test scores. If it is reasonable to assume that the student’s scholastic aptitude remains constant over some (say, six-month) period of time, then an extreme result observed at a particular point will probably be followed (“regress”) which is much closer to the student’s average. An abnormally high test score, for example, is likely to be followed at the next test by a lower score; and an abnormally low score is likely to be followed next time by a higher score.
Investors such as David Dreman and behavioural economists such as Richard Thaler and Werner De Bondt have uncovered strong evidence that regression to the mean, or something akin to it, occurs on financial markets. Using data extending back over several decades, they studied the securities of those companies whose prices over a given interval had either increased or decreased more than the market average over the period. Thaler and De Bondt concluded that “extreme returns of stocks listed on the New York Stock Exchange were found to be subsequently followed by significant price movement in the opposite direction.” If investors are either unduly optimistic or pessimistic about a particular company’s securities, and if that company’s fundamentals remain unchanged, then their stance will likely be reversed over time.
Very fashionable stocks and market segments thus become less exalted, and highly unfashionable companies and sectors return to average favour. Dreman in particular has demonstrated how the crowd’s exaggerated reactions, unwittingly aided and abetted by the mass media, occasionally offer tremendous investment opportunities to those who are prepared to stand apart from the crowd. If the price of an excellent company’s stock is savaged by pessimistic investors, mass media coverage and commentary to the point where it is considerably below its intrinsic value, then – as long as the company’s operations and prospects remain sound – the price of its securities will eventually recover. Conversely, if a company’s shares are inflated above their intrinsic value by euphoric buyers and media supporters, then – even when its operations and prospects remain unchanged – it is likely that at some point it will eventually fall from its exalted status.
The applicability to financial markets of regression to the mean is thus a salutary reminder that at critical junctures the mass media and the crowd can be mistaken. At these junctures their views do not reflect reality, but rather exaggerated perceptions of that reality.
Conclusion
Most people prefer most of the time to accept in an uncritical manner the information which they acquire from newspapers, radio and television. A compelling rationale justifies this stance: there are simply not enough hours in the day to start from first principles, adopt cautious assumptions and think for oneself with respect to all matters. More generally – and regardless of its rewards – anything which requires continual hard work, independent thought and occasional action which defies the crowd is never going to become common practice. Graham-and-Buffett style value investing clearly falls into this category.
 
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