Determining Signals from the Noise
Bloomberg terminals present users with a “Quote of the Day” every time they log on. The quotes vary widely on the profundity scale but frequently can be lumped together in the generally meaningless “Do Your Best” category. Occasionally, the terminal dishes one up that I fully agree with and that provides real context to delivering value to clients. This week, the “Father of American Psychology,” William James, is quoted, saying “The art of being wise is knowing what to overlook.” This strikes a chord with me because it gets to the root of what matters: what to pay attention to and what to dismiss. In digital electronics, this is separating signals from noise. Investors are faced with a firehose of data and news flow, but what are the signals and what is the noise?
We are in the midst of earnings season, when public companies are required to release their periodic financial updates. Announcements wherein companies meet (or nearly meet) analyst expectations are frequently non-events. It’s when companies announce one thing when analysts are expecting another that stocks can make big moves. A big move in one stock can move its entire sector and sometimes that can spill over into the broader market. A widely-watched and popular social media company announced an earnings miss on Friday, sending its shares down 39%. This move took many of its internet peers down as well, as investors extrapolated that company’s problems to others. Was this announcement a signal or was it noise? I consider it noise for several reasons. First of all, the revenue shortfall versus expectations was small, missing estimates by -2.6%. This is negligible because the company still managed to bring in over $1.1 billion in revenue. Second, the company’s user base, while growing at its slowest pace in the U.S., continues to explode in overseas markets. India is its largest single market, with 126 million users and is growing rapidly. Third and most important, this particular company exhibits faddish user engagement. As its users age, their use of the platform falls off. To the company, this is a looming issue, representing its slice of the “internet pie.” As a spillover effect to internet cloud providers, this is absolutely a nonissue because the “internet pie” continues to grow apace. Regardless of demand for a particular app, website or service, the demand for internet infrastructure is only going to be higher in the future. Despite being a signal to this particular company’s investors, its announcement should be regarded as noise to the broader market.
Monkeypox is coming! The World Health Organization this week declared Monkeypox a global emergency, citing outbreaks in 75 countries. Yes, this is an attention-getter and strikes fear into the hearts of a Covid-weary public. For investment purposes, however, it is noise. Fear sells news. Yes, Monkeypox is contagious and not to be taken lightly, but at this stage, it appears to be transmitted via close, intimate contact. Given that, a widespread outbreak seems unlikely and therefore this issue is more noise than signal.
Source: Bloomberg
Wheat, corn, gasoline and other major commodities continued their weeks-long price declines. Russia and Ukraine reached a deal to resume grain shipments from Ukraine’s Black Sea ports, driving wheat and corn prices down. Gasoline prices fell for the fifth consecutive week. Sharply higher inventories and depressed demand during what is typically the height of driving season drove (excuse the pun!) gasoline prices down. These data points are signals. Because commodities like these form the foundation for much of what is consumed in our economy, their price levels are important to monitor. With inflation in the cross hairs of the Federal Reserve, any easing of inflationary pressures is noteworthy.
These few examples typify my approach to news flow. Is it relevant or not? Given the endless and nearly infinite supply of news and data, it is critical to be able to distinguish the helpful (signals) from the unhelpful (noise). Focusing on relevant data drives our investment process and results in appropriate investment strategies geared to serve the wide-ranging needs of ACM’s clientele.
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