May 2011
Does news help us to manage a portfolio?.
Most stock market participants are news junkies. Every little morsel of data is assimilated to try and get an edge on the right price for a security or an asset class. These days, in a world of 24 hour news, there is no end to it, although how much of it is news rather than recycled press releases, gossip and speculation is more debatable. In the financial world news can be hugely valuable, which is why regulators go to such lengths to control it. Corporate results are released on a carefully controlled timetable and only through recognised channels. The ultimate news is “inside information” and that is rigorously controlled everywhere, even though the evidence suggests it doesn’t prevent it.
Apart from corporate news there is also geopolitical news. How will civil unrest in one country affect oil prices and what impact might elections have on taxes and government policy. Many claim this is the meat and drink of money management and managers are devoted to ensuring that they know exactly what is going on and making sure their clients know that.
It is worth considering though just how important news is in managing money. After all while everyone might wait with bated breath for a results announcement in practice share prices do not tend to move a lot in trading after the event. The common off the cuff remarks from analysts to a set of results is more often than not a dismissive “In line with expectations”. The best summation of the approach to result’s releases was the oxymoronic question once posed by a salesman to an analyst: “Are you expecting any surprises?”
The quest for news is a fundamental part of man’s curiosity about recent events and for clues as to what might happen next. In reality the humdrum flow of news does not make much difference to day to day portfolio management. For a start financial data is always out of date. At best results are released weeks after the end of a reporting period and in some cases it can be months. That means the financial conditions relevant to those results might be fifteen months old. That is a lifetime in markets. More importantly trying to predict business conditions is extremely difficult, let alone how companies will be impacted by them. The best that can be hoped for is the steady continuation of the existing environment.
In practice companies plod along delivering routine results accompanied by fairly mundane statements which analysts pore over to extract some morsel of data that might make a difference to the share price in 18 months time. In practice this task is all but impossible for the simple reason that so many people are doing it and every discrepancy is exploited. This is the iron logic of the Efficient Market Hypothesis.
Nevertheless, that is not to say the market is perfectly priced. On April 21st 2010 the Macondo 252 well that BP was drilling in the Gulf of Mexico blew up spectacularly. Not only did it impact the dividend for 2010 that disaster will probably shape dividend and company strategy for the next twenty years. But how many analysts recommended selling the shares when the news broke?
In terms of wealth destruction few events can match the implosion of the banks in 2008. But you wouldn’t have sensed that from reading the results announcements from the banks in 2007. To some extent companies have to dress up their public announcements. Even so, the statements from Chuck Prince, CEO of Citicorp, that it was “still dancing” in 2007, or the dividend increase announced by Fred Goodwin at RBS in early 2008 must surely define financial hubris. The real news event that presaged the crash was a short statement from some French hedge funds in the early summer of 2007 that they were suspending redemptions because of liquidity issues.
Most news is reassuring and does not prompt immediate any action. In contrast this news on liquidity and Macondo should have been triggers for trades. The fact that few people did so is perhaps more a reflection of the news overload that we all suffer. How do we know which piece of news is important, and should prompt some activity, and which news merely reassures us that our current position is the correct one?
In practice there is no mechanism to filter news. It is up to the individual to assess each item in turn for its importance, but who has the time to do that? The scale of the task, even for a manager focussed only on UK equities, is staggering. There are almost 700 companies in the UK All Share Index excluding investment trusts. Each reports results twice a year so there are 1,400 sets of results to be digested in the 200 working days available. On top of that each will deliver trading updates at the end of each reporting period. Then there are corporate actions such as rights issues and takeovers. Before we even get to political and economic data the portfolio manager is faced with 15 items of news ever day. Add in events like the death of Bin Laden or the Bouazizi inspired civil unrest in the Arab world and the information overload becomes overwhelming.
It is possible to limit the task by restricting the universe to the larger companies. After all, a 1% move in a company like Vodafone that makes up 5% of the index is much more significant than a 10% move in share like Drax that only accounts for 0.1%. However, focussing on the larger stocks makes it even more difficult to trade on unique information because they are such well researched stocks. What will the 41st analyst to cover Vodafone find that the other 40 haven’t?
In terms of responding to the political news around the world we have seen in recent months perhaps Chinese Premier Zhou Enlai got it right when he was asked what he thought about the French Revolution. He said it was too soon to tell. Focussing on what we know is more rewarding than speculating on what we don’t.