Warren Buffett’s wise decision to base himself in Omaha, far from the chatter of Wall Street, was affirmed by two recent news events.
These events – the International Monetary Fund’s series of U-turns in early September on its widely scrutinised global economic assessment and the market’s increasingly confident bet that Bank of England governor Mark Carney has got it wrong about the timing of the interest rate cycle – highlight the danger of the modern world’s slavish attention to breaking news.
The charitable interpretation of the IMF’s revisions is that things have changed in the last four months. The less favourable conclusion is that no one, not even the IMF’s pointy-headed analysts, knows what’s going on.
Furthermore, UK investors are now so confident about an economic recovery that they’ve pencilled in higher rates nearly two years sooner than the Bank of England, suggesting that even when investors get information they think they can rely on, there’s not necessarily agreement on what it actually means.
The obvious corollary is that any investment approach that relies on news headlines and forecasts is doomed to fail.
It’s complicated
This all reflects a well known feature of behavioural psychology: the tendency to ascribe greater importance to the most recent information. For example, the difference between the Bank of England’s view and the market’s comes down to interpretation, with investors giving more weight to recent positive news on the economy than the bank is prepared to do.
A further complication when analysing the news is deciding how much is already in the price. Sometimes it’s more than you think and sometimes less. As Jimmy Goldsmith famously pointed out: when you see a bandwagon, it’s too late.
But it’s more complicated than this because very often at the individual stock level good news is not built into valuations until some time after it has become publicly available. Especially at the smaller end of the size spectrum, the market is just not that efficient. This means that contrary to markets as a whole, where it can be better to travel than to arrive, good company news can be the trigger for sustained outperformance as investors slowly accept the improved outlook.
The limitations of knowledge
This might sound like a counsel of despair for investors, but it shouldn’t. Awareness of the limitations of knowledge is actually strangely liberating when it comes to managing investments. If you accept the folly of forecasting, you can concentrate on the facts, relying, for example, much more on a 10-year record of dividend growth than a broker’s earnings forecast for the next couple of years. If you accept that timing the cycles is bound to fail, you will invest according to the long-term inevitable themes, such as demographic change, and less on what organisations like the IMF think might happen this year. You will make sure that you are well diversified because you will accept that neither you, nor anyone else, really knows what is around the corner. You might even move to Omaha.
Tom Stevenson, Investment Director, Fidelity Worldwide Investment
