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Tuning Out the Noise to Be a Better Investor

Ser Jing - Tuning Out the Noise to Be a Better Investor (pic)

I recently sat down for coffee with a friend who works at a bank and he was telling me of the difficulties that individual investors face when trying to tune out the noise to focus on what’s truly important in investing. Sadly, I think he’s spot on.

We’re constantly barraged by an endless flow of economic data, statistics and experts’ views, with each painting a different story.

Ask fund manager John Hussman, a former professor of economics and international finance at the University of Michigan, what he feels about the stock market in USA, and he’ll likely tell you it’s headed for disaster as corporate earnings are bound to fall. According to Hussman, fat corporate margins would shrink from its current unsustainable all-time highs and drag earnings along with it.

But, prod Wharton School finance Professor Jeremy Siegel about profit margins and he thinks they’re fine. To him, there’s even room for the Dow Jones Industrial Average, currently at 15,116 to run up to 18,000 by the end of the year. And that, is just an excerpt of the kinds of conflicting views that experts have on the markets.

In terms of economic data for Singapore and the rest of the world, let’s see a sample of what’s penned on the calendar this week.

For Monday, there is:

  • Singapore’s May Electronics Sector Index and May Purchasing Managers Index.
  • USA’s May Purchasing Managers’ Index and April Construction Spending

On Tuesday, we have:

  • Japan’s April Labor Cash Earnings
  • UK’s May Purchasing Managers’ Index for Construction
  • USA’s April Trade Balance

Moving on to Wednesday, we get:

  • Eurozone’s First Quarter GDP and April Retail Sales
  • USA’s May Non-manufacturing Composite Report

Overwhelmed? That’s just Wednesday and we’re not even done yet! Unfortunately for some investors, they are constantly kept busy just by trying to keep abreast of all these reports of various economic data and indicators, thinking it’ll give them an edge.

But the thing is, more often than not, these data can’t help much in making investing decisions –they’re just noise. A term borrowed from physics, noise is something that obscures the true signal we want to detect. And in our case, the true signal would simply be “Is this a good business? And, can I get it at a good price?”

Mutual fund provider Vanguard published a paper on October last year that studied how well various economic and financial indicators fared in predicting both short-term (1 year) and long-term (10 year) US stock market returns.

The study looked at popular numbers that some investors “believe or have shown to be correlated with future stock returns” such as; PE ratios based on trailing 1-year earnings; PE ratios based on an average of 10-years’ worth of earnings (also known as the Graham & Dodd PE ratio); US GDP-growth trends; 10-year average corporate earnings growth trends; dividend yields; and even 10-year average US rainfall levels to act as a reality check!

In all, there were a total of 16 different indicators that Vanguard studied and the results for long-term predictability are reproduced in the graph below.

Tune out noise

Why were the short-term predictability results not given? That’s because the study found that short-term stock returns were basically unpredictable.

The unpredictability of short-term share-price movements is not a surprise. What is surprising though, was how Rainfall (seriously…Rainfall!) is a better predictor of long-term stock market returns than other indicators that the public might take for granted to be very important in determining US stock market returns, such as US’s GDP growth Trends.

If the amount of rain can triumph over national economic indicators in being a stock market oracle, it just goes to show that most, if not all, information we take for granted to be important will probably be just noise in the investing arena in the long run.

Of course, this naturally begs the question, “What should we do?” The answer’s simple – we should focus on individual companies and how well (or poorly) their businesses are faring.

Retail sales reports in Singapore could not tell investors anything about how companies like Breadtalk (SGX: 5DA), Challenger Technologies (SGX: 573) and Dairy Farm International (SGX: D01) would fare, even though these companies are involved in food, technological gadgets and super-mart retailing respectively.

The reasons range from geographical diversity for their business operations such that statistics centred on Singapore are less meaningful (in the case of Breadtalk and Dairy Farm International), to a case of aggregated data being simply unable to capture fine-grained nuances of individual operators (in the case of Challenger).

At the end of the day, investing is really a game of chance where investors have the ability to stack the odds in their favour. But to do so, investors have to first recognise what truly matters in the stock market and then…tune out all that noise.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.