Markets: Separating Signal from Noise

Yesterday, we looked at the Investor’s Dilemma: Do you give in to your emotions and Panic, or do you follow your previously created Plan?

This morning, equity futures are strong. Does this mean the all clear signal has been blown? I suggest that the day to day twists and turns are not determinative in the least.

My own view is that any single day is meaningless noise. Indeed, on a longer term chart one can hardly spot the 1987 crash or 9/11 relative to the rest of the market action. The little squiggles are meaningless, the bigger ones mostly so. The back and forth traders engage in — up200/down300/up250/down150 — are like a rubber band getting stretched too far this way, then snapping back and going too far the other way.

Perhaps the best analogy to thunk about this are the swings of a pendulum eventually coming to a rest. Only markets never rest, and what seems like some calm are merely prices seeking stabilization in values. Since that is a function of actual earnings which rise and fall dependent upon ongoing economic activity, stability is more or less illusory. It is, at best, temporary.

One of the hardest thing for investors to do is separating the signal from the noise. Day to day action tends to be a meaningless back and forth, driven as much by liquidity and technical factors as actual valuation. What matters over time is the longer term trend: Is the economy expanding? What is happening with employment, wages and retail spending? Ultimately, these economic factors matter because they drive profits  — and traders.

You Humans have a hard time understanding the longer arcs of time beyond the next 5 minutes. Thinking about the next 5 quarters or 5 years is very much a learned skill. The challenge is to be able to step back from the here and now, and conceptualize the present within the bigger picture of the longer term.

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