Can investors trust the media?

Investors are swamped with tips in newspapers, on television and online, but are media pundits worth their salt? The media has always fed off individuals’ insatiable appetite to take a punt on the stock market – offering ‘expert’ tips and forecasts in a bid to sell newspapers to investors or direct eyeballs to a television show or website. There is little doubt these forecasts are highly influential.

In his book, Irrational Exuberance, economist and Nobel laureate Robert Shiller wrote: “The history of speculative bubbles begins roughly with the advent of newspapers… significant market events generally only occur if there is similar thinking among large groups of people, and the news media are essential vehicles for the spread of ideas.”

Sometimes, these ideas are gloriously right. In January 2013, UK newspaper The Independent included computer-chip maker ARM Holdings in its annual list of ‘10 share picks’ when the share price was 768p, quoting Charles Stanley’s Chief Economist Jeremy Batstone-Carr: “I think my stand-out (pick) would be ARM Holdings, but it’s far from cheap.” In September 2016, ARM was snapped up by Japanese investing giant Softbank for 1,700p per share, a 221% jump in just over two and a half years.

When they get it wrong

But there are also notorious clangers. And sometimes from highly credible commentators. Writing in the New York Times on US election night 2016, another Nobel laureate economist, Paul Krugman, wrote: “It really does now look like President Donald J. Trump, and markets are plunging (the S&P 500 fell over 6% from its high to its low that day) … If the question is when markets will recover, a first-pass answer is never.” The market ‘plunge’ turned out to be nothing more than a one-day blip. And from the low of that blip on 9 November 2016 to 25 February 2020, the S&P 500 was up 160%.

So, is there actually an opportunity for private investors to generate ‘alpha’ – or market outperformance – by following the calls of experts rolled out by the media? It is a question that has intrigued a number of academics, with one of the most prominent and specific studies conducted in 2017 by Professor David H. Bailey and others, who produced the paper, ‘Evaluation and Ranking of Market Forecasters’.

They analysed 6,582 forecasts of the US stock market, made between 2005 and 2012, by 68 ‘experts’ – including many prominent investment professionals who wrote in the media. And the results were not pretty.

On average, around 46% of forecasts were accurate. Only 23 of the 68 forecasters (34%) averaged over 50% accuracy, 11 over 60% and just four over 70%. Forty-five forecasters (66%) had an accuracy under 50%, with 18 under 40% and five under 30%.

Indistinguishable from chance

Bailey even suggests that the results might overstate accuracy. In a follow-up blog post, he wrote: “One question that remains from this study is to what extent our analysis, or those of any other similar study, are biased by the simple fact that unsuccessful forecasters tend not to remain in the business for a long period of time. Thus long-term accuracy scores and rankings (the only ones that are statistically significant) necessarily omit those forecasters who have dropped out … it does mean that all rankings and scorings may tend to be optimistic.”

When asked to comment on the implications of the research, Bailey is unequivocal: “Our conclusion is very clear. By and large most of these forecasts are indistinguishable from chance.”

He is also highly sceptical of how practical it would be for a private investor to profit from the forecasts of ‘winners’, saying: “Now while we did identify a small cohort of successful forecasters, who in theory could provide a private investor with the basis of a successful investment strategy, how on earth do you identify these winners early enough so their tips can be followed? I would also worry about the ability of any forecaster to maintain a strong performance for an extended period. There is certainly evidence to suggest that investors can ‘lose their touch’, or the investment technique they use becomes ineffective over time.”

To reinforce this point, Bailey highlights the findings of S&P Dow Jones Indices on US equity funds over three consecutive 12-month periods between 2014 and 2017. It found that out of 563 funds that were in the top quartile in the first 12-month period, only around 6% of these funds managed to stay in the top quartile by the end of the third period. Over five years, less than 1% of funds maintained their top quartile performance.

Bailey concludes: “If our research has helped the investing public realise that these short-cut techniques (aimed at beating the market) simply won’t work, then we’ve accomplished something useful. In a way it should be obvious that a market tip which is publicly announced is not exactly going to be information so valuable that a private investor can take advantage of it, particularly in today’s world of algorithmic trading where professional investors are spending huge amounts of money scanning for information that can give them an edge.”

The professional’s edge

Philip Smeaton, Chief Investment Officer of Sanlam Private Wealth UK, isn’t surprised by the results of Bailey et al’s research. He says: “It may surprise some private investors, but a ‘hit rate’ – the ratio of profitable to total investments – of 55 – 60% is really good, even for professional investors.”

Philip Smeaton, Chief Investment Officer of Sanlam Private Wealth UK, isn’t surprised by the results of Bailey et al’s research. He says: “It may surprise some private investors, but a ‘hit rate’ – the ratio of profitable to total investments – of 55 – 60% is really good, even for professional investors.”

But he stresses that hit rate is only one piece of the investing puzzle, and often, private investors don’t realise the importance of some of the other pieces.

First, hit rate is not just about investing skill level, but also to do with size of portfolio: “The chance of a single investment decision being right for a skilled investor is only marginally better than a coin toss. To make sure that this skill comes through in the results, many investment decisions need to be made – much more than would typically be made by a private investor – essentially diversifying away the luck element and allowing investment skill to dominate.” So, it would be incredibly hard for a private investor to achieve any sort of consistent hit-rate simply because they don’t have the time to make a sufficient number of diversified investment decisions.

Second, and perhaps even more importantly, is how ‘winners’ and ‘losers’ are managed. Phil says: “I doubt very much that, at the time of making an investment, private investors are thinking there is at least a 40 – 45% chance of that investment having a negative return. And probably even less thought goes into how to manage those losers. But that is what investment professionals spend a lot of time thinking about. We want to make sure that when we’re wrong, the damage is mitigated – that we’ve understood the risks around the size of the position and the potential for downside in the share price. Also, when we’re right, we want to make sure a winner has a good chance of having a significant impact on a portfolio.”

To illustrate the point, Phil highlights the Sanlam approach of investing in ‘high-quality, resilient companies’ – for example, those with a strong balance sheet, steady margins that don’t move dramatically through the business cycle, and which are protected to a degree by high barriers to entry. “Even if an investment in such a company turns out to be a loser,” says Smeaton, “it’s not going to go wrong in a disastrous way,”

He also cites the professionals’ advantage of being able to understand the potential downside of an investment in a lot more detail than a private investor would. For example, Sanlam is invested in Intercontinental Hotels, a business clearly exposed to a downturn as a result of the coronavirus. But Sanlam’s analysts have the skills and resources to model various scenarios that may play out, assess the likelihood of each scenario occurring and the detailed financial impact they would have on Intercontinental Hotels – enabling Sanlam to take an appropriate decision on what to do with this holding. This exercise would be beyond nearly all private investors.

When asked specifically about the usefulness of investment tips in media, Phil says that no one should ever forget that the media, even the financial media, is primarily about entertaining. He says: “Ultimately, a media company’s aim is to sell advertising space, newspapers or subscriptions, and it does that by entertaining. Its primary focus is not to help people make money and it’s not judged on that basis. The focus is just about moving from one shiny new idea to the next.”

Put another way, a headline reading ‘Buy a reasonably priced diversified investment portfolio attuned to your risk profile and personal goals’ is unlikely to generate many clicks or increase readership. And even if you were to base investment decisions on the advice of financial journalists, don’t expect them to be accountable for bad calls.

Faced with a scarcity of successful market tipsters, an almost impossible task of picking these winners, and the portfolio management challenges described by Phil Smeaton, it seems chasing alpha by following tips in the media is a fool’s errand for the private investor.