Fake-ish news

 By Guest Blogger Doug Rowat

Unlike Donald Trump, I would never accuse the mainstream media of lying. They’re basically an honest bunch. However, they’re certainly selective regarding which stories they highlight. So, let’s call them honest but misleading.

The main reason for this, of course, is because fear sells. A story with modest journalistic merit but lots of anxiety-generation potential will always feature prominently. If you can frighten someone, you’ve likely picked up a reader or viewer of your content. But fear, though provocative, is not useful for investors. Fear misleads.

With this in mind, let’s also look at Bayes’s Theorem. Thomas Bayes was an 18th century English statistician, philosopher and minister most famous for his examination of the probability of certain events, specifically changes in probability when new information is introduced. Farnam Street sums up Bayes’s Theorem this way:

Knowing the exact math of probability calculations is not the key to understanding Bayesian thinking. More critical is your ability and desire to assign probabilities of truth and accuracy to anything you think you know, and then being willing to update those probabilities when new information comes in.

As a simple example, if the outcome of a dice roll is unknown, your odds of correctly guessing the right number are about 17%. However, if your friend takes a peek first and tells you that it’s an even number then your odds of correctly guessing shoot up to about 33%. However, you happen to be playing this dice game at a Yale kegger and your friend is Brett, a heavy beer drinker and all-round unreliable guy. This information should now be factored into your guess. It might be best to assume that your odds have dropped back to 17%.

News stories are like dice rolls. You might feel certain that you can guess their accuracy, but if you don’t account for the ‘fear factor’, you’ll make incorrect conclusions. Staying unemotional and assigning probabilities to the predictions made in such stories is critical. The media are like your drunken buddy Brett—loud and attention grabbing, but, in the end, probably leading you astray.

A good example of this can be illustrated by plotting news-story keywords against market direction. Looking at instances of the word ‘recession’, for instance, is revealing. Mentions of the word peaked at almost the exact financial-crisis bottom. Now, obviously, we don’t know the exact context of each of these news stories, but it’s a safe bet that in 2009, with a primed and shell-shocked investor audience, the media wasn’t publishing stories with rosy economic forecasts. More likely the content had a doom-and-gloom slant. Remember, fear sells. So, as it probably turned out, when the media was pumping out the highest volume of frightening stories about the economy, the best buying opportunity in a generation was indicated.

Bloomberg news stories mentioning ‘recession’ (white line) vs the S&P 500 (orange line)

Source: Bloomberg

And here’s another illustrative chart indicating the overall uselessness of scary predictions:

Keep this chart in mind when the negative forecasts start appearing following last week’s sell-off… (click to enlarge)

Source: Tradenavigator.com

So, employ Bayes’ Theorem when you hear terrifying market predictions or read alarming financial news stories. Don’t allow them to result in emotional investment decisions. Consider, for instance, if the experts quoted are always bearish. In other words, apply a probability of truth.

It’s best to keep a sober outlook with your hard-earned investments. Let Brett chug the beer.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.