Yesterday, we looked at the Investor’s Dilemma: Do you give in to your emotions and Panic, or do you follow your previously created Plan?

This morning, equity futures are strong. Does this mean the all clear signal has been blown? I suggest that the day to day twists and turns are not determinative in the least.

My own view is that any single day is meaningless noise. Indeed, on a longer term chart one can hardly spot the 1987 crash or 9/11 relative to the rest of the market action. The little squiggles are meaningless, the bigger ones mostly so. The back and forth traders engage in — up200/down300/up250/down150 — are like a rubber band getting stretched too far this way, then snapping back and going too far the other way.

Perhaps the best analogy to thunk about this are the swings of a pendulum eventually coming to a rest. Only markets never rest, and what seems like some calm are merely prices seeking stabilization in values. Since that is a function of actual earnings which rise and fall dependent upon ongoing economic activity, stability is more or less illusory. It is, at best, temporary.

One of the hardest thing for investors to do is separating the signal from the noise. Day to day action tends to be a meaningless back and forth, driven as much by liquidity and technical factors as actual valuation. What matters over time is the longer term trend: Is the economy expanding? What is happening with employment, wages and retail spending? Ultimately, these economic factors matter because they drive profits  — and traders.

You Humans have a hard time understanding the longer arcs of time beyond the next 5 minutes. Thinking about the next 5 quarters or 5 years is very much a learned skill. The challenge is to be able to step back from the here and now, and conceptualize the present within the bigger picture of the longer term.

Category: Investing, Markets, Valuation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

18 Responses to “Markets: Separating Signal from Noise”

  1. PDS says:

    Yes indeed BR…for we “humans”….(aka mere mortals)….long term is lunch…but the real challenge for investors and those of us who manage money professionally, is synthesizing all of the media white noise and coming up with a rational long term investment strategy that is performance value added….Too Much Information!!

  2. number2son says:

    Based on the status of my retirement funds, long-term this human sucks. ;(

  3. Chief Tomahawk says:

    Aye! The animal spirits seem to be fleeing gold this morning…

    Greece is okay again so let’s all toga! toga! toga!

    http://www.youtube.com/watch?v=3AohA367VVk

  4. [...] Separating signals from noise in the markets.  (TBP) [...]

  5. cmellen says:

    Short-termism is a very dangerous thing. Humans have become far too focused on the short term and has been neglecting the long term for quite some time. We hear it with the green energy debate “why should we subsidize something that will take 30 years to get up and running” and we see it earnings reports where companies no longer give 3-5 or even 10 year plans. Neglecting the future is dangerous for your health.

  6. low-tech cyclist says:

    “You Humans have a hard time understanding…”

    Barry Ritholtz: space alien, visitor from another dimension, minor deity, or something else entirely?

    I, for one, welcome our new Ritholtzian overlords.

  7. ancientone says:

    The quote by Calvin Coolidge shows that even an admirable personal philosophy is worthless if your economic philosophy is brain dead wrong.

  8. machinehead says:

    The ‘noise’ I noticed was VIX reaching almost 40 again yesterday, on the third of a series of rising lows in August.

    Despite the lousy fundamental backdrop, the technical action is just bullish as hell … for now. (Mind you, this is not a Dow 36,000 call!)

  9. Mark Down says:

    “Hardly spot”….. 500 drop the Friday before! Maybe ‘noise’ should be looked at a little closer.

  10. David in D says:

    Humans focus on the short term because we have evolved to do so. 100,000 years ago, it was the person who rapidly ran from a ‘rustling in the bushes’ who consistently survived and passed on their genes. While thinking long term is definitely advantageous in a ‘rational’ world it is completely counter our learned behavior (instincts).

    Furthermore, ‘rationality’ is not something that hangs out in space and is objective. It is, instead, (to use the terms of the great French sociologist Emile Durkheim) the ‘collective representations’ that societies mutually agree upon. This ‘agreement’ occurs below our rationality and thus is completely determined by the larger pack.

    All this is to say that I think Barry is correct about attempting to think long-term, but this is very difficult for homo sapiens to do and is not always rewarded given the subjective nature of ‘rational.’

  11. baillebeag says:

    I find using weekly charts, instead of daily, helps with noise reduction.

  12. kaleidic says:

    The markets have become the tail wagging the dog:

    One mind-boggling result cited by Alan [Newman] of the banks becoming prey to the casino mentality is that dollar trading volume now weighs in at four times gross domestic product — that’s right, quadruple GDP — and up a full tenfold what it was from 1926 to 1999. We’ve become a nation of paper swappers. — Alan Abelson, Barron’s, Sept 3, 2011

  13. ES says:

    I don’t think it is humans who run the market these days. It is the algorithms. When humans ran the market it used to be more rational and docile most of the time, except for panicks. Tehse days , one day we get a full blown panick and nex day the sky is blue. I don’t think it even relates to the news. There is no way anybody believes the daily stream of lies coming out of Europe or US. The market is a thing in its own right, self-contained, with its own transmission mechanisms such as liquidity.
    We, humans, just pretend that we understand something. In reality, there is nothing to understand because we don’t know the forces that move the market, but they are not “news”. The only thing we can can rationally do is to watch the trend and watch liquidity.

  14. The best way to trade is with the newspaper filed firmly in the round filing cabinet

  15. macrotrader603 says:

    selling low volume rallies in a downtrend is the correct trade until the trend turns up

  16. Frilton Miedman says:

    Fondly remembering so long ago, two months or so, with a smirk, James Altucher calling for A Dow 20,000 in 2012.

  17. DuchessGateau says:

    I think I’m fairly good at discerning the difference between noise and signal. Consequently, I’m a reality-based chump. Meanwhile, others create their own signal. The ratings agencies decide whether U.S. credit is AAA or AA. Reality be damned. Apparently there’s a timeline, or we crossed a mysterious threshold, and they downgraded the U.S. If you know what that threshold actually is, you may hold the key to predicting the future.

    Today there are noises about Iran’s nuclear program coming from the NYT, WSJ, CFR, and David Sanger (time to pay attention?). Sanger usually = signal. The assessment is actually from the IAEA, not U.S. intelligence. But when noise is given legitimacy, it is no longer noise. So if U.S. intelligence agencies “come on board,” and announce that Iran is a nuclear threat, that’s the signal. That means war. It’s easy to create reasons for war, and they don’t even need to make sense. But what are the timeline and actual thresholds?

  18. OscarWildeDog says:

    As I have said several times in response to these posts, my long term strategy has nothing to do with fundamentals, technicals, the macro or the micro. Alpha and beta be damned, EMT – see ya later, dude! No, you cannot explain a market that takes one of the top companies in the world – in this case, Exxon – and drops it’s price over 20% in a couple of weeks. Now, XOM is no PALM, RIMM or even LULU, either, but you can’t tell me the underlying value changes that much. Yes, I know all the stories about “over-corrections,” the “rubber band/snap-back” theory, and occasional irrationality. But to have ANY stock fall prey to what some dickhead Greeks do or don’t do is preposterous. Yep, it’s one big casino game.

    So, what do I do? As I’ve stated previously, I love these violent swings! Everybody gave me grief while I was selling puts on the VXX all the way down (and pocketing some handsome coin doing so, while simultaneously selling covered calls on the positions which were assigned to me. Now I am famously selling calls all the way up on the VXX. I’m selling OTM calls after gaps up with volatile stocks, and ditto with puts after violent gaps down. Boy, this is fun! I don’t give a damn about 200D MA, bollinger bands, forward P/E’s or free cash flow. Irrelevant.