Noise has always been a part of the financial markets. Fischer Black wrote a seminal paper on the topic of “Noise” in the Journal of Finance back in 1986. From the paper’s abstract:
The effects of noise on the world, and on our views of the world, are profound. Noise in the sense of a large number of small events is often a causal factor much more powerful than a small number of large events can be. Noise makes trading in financial markets possible, and thus allows us to observe prices for financial assets. Noise causes markets to be somewhat inefficient, but often prevents us from taking advantage of inefficiencies
Since that time not only has the amount information we receive on a daily basis increased, but so has the amount of noise. If anything the Internet age has made the challenge of sorting signal from noise even more difficult.
An example of this is the growing number of official (and unofficial) economic indicators. Izabella Kaminska at FT Alphaville has a great graph showing the rise in the number of economic indicators released on a daily and monthly basis.
Source: FT Alphaville
As one can see we are increasingly inundated with economic data. What is not clear whether all this “indicator bombardment” makes for better investors. Cleve Rueckert at Birinyi Associates, the source of this observation, is likely no.
This helps explain the recent challenges of following your favorite guru. Joe Weisenthal at Clusterstock notes the many turns noted strategist Barton Biggs has taken in the past few months. Biggs may in fact have a coherent world view from which he is generating market calls. However periodic check-ins from the media make for a choppy, market-driven outcome that makes him seem like a flip-flopper. Then again, he might just be a flip-flopper. The noise generated by the drumbeat of news and indicators makes it difficult to follow any one who does not firmly reside in the perma-bull or perma-bear camp.
Another challenge for market participants is that we so badly want to find patterns in the data we see. There is nothing more appealing to the media than a streak at work. One need only look at the case of Bill Miller to see how this played out. As Miller continued to outperform the S&P 500 on a calendar-year basis his streak became more and more attributed to skill versus luck. This should not be all that surprising. A recent post at the Farnam Street blog notes how misunderstand the nature of randomness. In short, we ascribe intentionality to processes that are often purely random.
One can see how this problem would only get worse as the amount of information explode. The question for investors and entrepreneurs is how to deal with it. The application of technology to the problem is a likely outcome, but for investors that means relying on algorithms that are at best opaque and at worst entirely black box. If and when those algorithms fail it is difficult, if not impossible to diagnose the issue.
For those more old school it may come down to a more simple solution. Seth Godin writes:
As the amount of inputs go up, as the number of people and ideas that clamor for attention continue to increase, we do what people always do: we rely on the familiar, the trusted and the personal…The incredible surplus of digital data means that human actions, generosity and sacrifice are more important than they ever were before.
Generosity and sacrifice are not things we commonly attribute to financial market participants. However it may behoove investors to think about what sources of information, data and opinion they can rely on in an increasingly noisy financial world. Otherwise the only sound you hear may be white noise.
