Comp II Final

There have been many theories regarding how non-financial data affects stock price in the short term. Efficient Market Theory is a way of thinking about how and what influences stock price. Irving Fisher, a pioneer in economics, laid the building blocks for what became Efficient Market Theory. Fisher believed that “the prices prevailing on Wall Street were a reflection of economic reality and not of investor mania or a credit bubble” (Fox, 2009, pg. 44-46). This was shockingly proved wrong when the market crashed in the 1930s, and many times since. A follower of Fisher, Eugene Fama believed that news was disseminated through the market efficiently and price immediately reflected current news and events (Time, 2009). One opponent to this school of thought, Robert Shiller, has taken the position that while news may be disseminated efficiently, it is not absorbed and acted upon as quickly as Fama believed. The fact is that stock values are affected by many different variables. When it comes to news, there are two types that influence a stock’s volume. The first type of news consists of facts and events reported about the company, referred to here as hard news. The second would be opinion reported about a company, referred to here as soft news. This soft news, consisting of financial editorials, opinion polls, blogs, and investment analysts’ expectations has predictable short term effects on stock volumes. This allows for the creation of a new technical indicator showing the direction of short term market sentiment.

There are several conventions that define the scope of this essay. There is a marked difference in the types of media data that affect stocks, stated earlier hard news; consisting of earnings reports, SEC filings, and legal actions normally affect price very quickly and usually have long term effects. Along with hard news, inevitably comes the soft news; editorials, investment analysis, blog posts, and opinion polls. These types of news being opinions based on fact are not generally seen as having as great an effect on the volatility and price of a stock. Although, when looking at some markets, trends can be seen that may disprove that generality.
There are currently two accepted way of analyzing the markets, fundamental analysis and technical analysis. Fundamental analysis looks at the quarterly and yearly reports filed by a company with the SEC in order to determine the overall health of the company. Fundamental analysis also takes into account marketing and management strategies in order to help the investor make investment decisions. Technical analysis focuses on the recent price and volume activities of a company and is used as a forecasting tool to predict short term change in price. Both of these types of analysis rely heavily on math and logical concepts. This reliance on math is the reason previous generations have said the markets should act rationally.

Markets cannot be rational because the people trading and investing in them are not always rational. To describe this characteristic Shiller calls them “Animal Spirits.” Shiller describes animal spirits as the psychological drivers of market movement. Looking at media activity is not a standalone investing strategy. Media activity is a tool that can be used to determine market timing and the overall response of investors to the market.

While researching the vote to legalize recreational use of marijuana in California, Proposition 19, a trend was discovered in media volume increases of soft news. Volume data was gathered for 8 stocks that have direct income from the medical marijuana industry in California and compared to the number of news articles written about Proposition 19.

Figure 1: Soft News Activity (Data Gathered from Google News). Chart can be viewed in previous post Presentation for Comp II Final.


In Figure 1, between Oct. 4 and Oct. 6 of 2010, there was approximately a 100% increase in the 5 day SMA (simple moving average) of the volume of articles written about Proposition 19. There was a corresponding increase in the 5 day SMA of stock volume several days later, as seen below in Figure 2.

Figure 2: Sector Volume Activity (Data gathered from Etrade.com) Chart can be viewed in previous post Presentation for Comp II Final.

In this example, other data was looked into as being the cause of the stock volume increase but none could be found other than the news in relation to referendum. The preceding increase in article volume may not be the only reason for the change in stock volumes, but it is a definite indicator of interest in the group of stocks. This interest alone can be the cause of market movements.

A second more recent example began March 17th. Medical Marijuana Inc. released a letter of intent to merge assets with HDDC. There was no immediate action in the market. March 24th the Merger was finalized, still with very little action in the market. There was an increase in the volume but still no substantial price movement. On March 28th investors finally accepted the news and volume increase significantly. March 29th brought news of the initial transfer of assets in the amount of $40 million, and another transfer of assets on the 31st of $4 million. This represents an almost 300% price increase over a one week period for news that began almost 2 weeks earlier.

Figure 3: Stock chart for Medical Marijuana Inc. March 1 through April 4. Chart can be viewed in previous post Presentation for Comp II Final.

In the case of Medical Marijuana Inc. the price drop after the new 1 year high was reached on March 30th was not the result of news but of a reaction to a technical indicator. Short term investors were exiting the trade after in some cases a 100% profit from the initial trade.

In the book Irrational Exuberance, Robert Shiller describes this as “Attention Cascades.” This effect can be seen in the very small scale within the OTC (over the counter) stock markets. There are several steps to this process. Penny stock investment advisers will put out a press release that they are beginning analysis of a company. During this analysis time the investment adviser will hype up any news about the company as much as possible, and finish by announcing that they are buying the target company’s stock. The volume of the stock will skyrocket for a period of time, then plateau. The stock volume will then return to historical levels.

Sheldon Lewis of Mainsail Partners in San Francisco believes hard news and soft news could be separated by “looking at the timing of the event versus the timing of the news regarding that event. “When an event occurs … the first to react are traders. Subsequently, people write news, blog, or tweet about the event.”(2010) By separating hard news from soft news you can begin to separate long term activity from short term consensus. With more research a technical investment indicator could be developed from this data. As a leading indicator of short term market sentiment, soft news could indicate entry points to new market positions. As the progression through the media cycle continues, an exit point to the trade would be indicated by either a decrease in soft news volume or a change in the direction of sentiment, as was the case with Proposition 19. Several days before the referendum, opinion poll results switched from support for the law to being against the law passing. There was a change in direction of the money flow within these eight companies at that time, signaling the exit for the trade.

When Shiller argued, “as the main source of public information about the stock market’s performance, the media will continue to have a tangible impact on the paying out of significant market events.” (2001) He could not have imagined what the face of media in this decade would look like. With the number of financial blogs, bulletin boards, forums, and websites streaming to our phones, laptops, desktops and TVs, each piece of news shaping our opinion of the market.

References:
Akerlof, G., Shiller, R. (2009) Animal Spirits, Princeton University Press. New Jersey.
Jung, J., & Shiller, R. J. (2005). SAMUELSON'S DICTUM AND THE STOCK MARKET.
     Economic Inquiry, 43(2), 221-228. doi:10.1093/ei/cbi015
Shiller, R. J. (2001). Exuberant Reporting. Harvard International Review, 23(1), 60.
     Retrieved from EBSCOhost.
The Path of a Powerful Idea. (2009). Time, 173(24), 44-46. Retrieved from EBSCOhost.
Fox, J. (2009). The Myth Of the Rational Market. Time, 173(24), 44-46. Retrieved from EBSCOhost.