Skip to the content

Why the fund world needs to drop its obsession with short-term movements

30 June 2015

It’s high time the investment world recognises that its hit and miss obsession with trying to explain short-term market movements has very little to contribute to a sensible long-term investment process, according to Old Mutual’s Liam Nunn.

By Liam Nunn,

Old Mutual Global Investors

It’s been pretty much impossible over the past couple of weeks to avoid the media circus surrounding the group of backpackers that stripped naked on top of Mount Kinabalu in Borneo (allegedly thereby angering the resident spirit gods just days before a tragically lethal earthquake struck the area).

And while it has subsequently emerged that the causal link between the naked backpackers and the earthquake likely existed more in the minds of headline-hungry Western journalists than in the beliefs of the vast majority of the local population, the story undeniably struck a chord with the British public.

After all, what could be more eye-grabbingly ridiculous to a modern audience than the claim that a causal link exists between stripping backpackers and the movement of the earth’s tectonic plates?

However, remote tribal religions and ropey tabloid headlines don’t have a monopoly over such spurious arguments. Open up the financial section of any newspaper tomorrow and you’re likely to be greeted by a vast array of causal claims: ‘European Equities Decline on Industrial Data’, ‘Dovish Fed Comments Weaken the Dollar’, ‘Construction Sector Falls as Economists Downgrade GDP Forecasts’ etc.

While these headlines sound instinctively more plausible than ‘stripping backpackers cause fatal earthquake’, the claims of causality embedded within them are often similarly weak and the veneer of plausibility makes them all the more likely to be uncritically absorbed by readers.

When economists David Cutler, James Poterba and Larry Summers performed a detailed study of the 50 largest single-day share price movements since the Second World War, they somewhat surprisingly discovered that around half of those movements couldn’t be convincingly explained by the release of new information or observable events at the time.

In other words, despite the way market movements are routinely reported and analysed by market participants, even the most dramatic aggregate price fluctuations often lack a clear casual explanation.

But of course – because recognising this fact would undermine the standard equilibrium models of economics (and perhaps also reveal the financial world to be even more chaotic and frightening than it already appears) – we tend to construct false narratives to fit the data we’ve just observed.

The human mind is often guilty of automatically seeking causation when confronted with mere correlation. When we watch price tickers flying around on our Bloomberg screens, we instinctively grasp at anything that sounds like a viable cause and latch onto it like a lifebelt in a fast-flowing stream.

But as the study above shows, at least half of the time the stories we tell ourselves are little more than convenient myths: no more intellectually robust than arguing that the anger of puritanical mountain gods caused a major earthquake.

The relevant investment point here is that we need to recognise that short-term market movements are noisy by nature; and that spending a large proportion of our time trying to explain them is likely to be at best futile and at worst damaging to the investment process.

Firstly, because it’s likely to encourage excessive short-termism (and costly over-trading) by making past short-term price movements appear inherently more linear and predictable than they actually were at the time (an effect often referred to as the ‘narrative fallacy’).

 

And secondly, because the more time investors spend trying to impose artificial narratives onto the path of short-term market movements; the less time they’re likely to spend focusing on the proven long-term drivers of share price performance: namely the fundamental qualities of the individual businesses in question and – most importantly – the price at which those businesses can be purchased. 

Just as we have grown to accept that superstition has nothing of value to contribute to our understanding of how earthquakes occur, we should recognise that our hit and miss obsession with trying to explain short-term market movements has very little to contribute to a sensible long-term investment process.

Liam Nunn is a member of Old Mutual Global Investors’ European small-cap team. The views expressed above are his own and should not be taken as investment advice.

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.