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Wednesday, June 8, 2011

On the Myopic Hyperbole of Wall Street

I suppose that after looking at something closely for a long period of time, virtually anyone would perceive a small change in it as huge. This is reflected in how people formulate graphs. In particular, typically only a small interval is shown, the perceptual impact of which is that small changes look big. For example, msnbc.com reported on June 8, 2011 that the price of oil “soared” on that day “almost $2 to near $101 a barrel.” My reaction in reading the report was that the word “soared” indicates a lack of perspective on Wall Street and the media.

To be sure, a graph showing the price of oil with the y-axis running from $98 to $102 would show what looks like a huge increase, while a y-axis extending from $0 to $150 would show a barely noticeable change on June 8th.  The second graph would be more accurate in terms of the significance of the change.

The modest increase in price was momentary, caused by investors who had shorted oil and wanted to get out because of a bearish expectation. On June 8th, the Organization of Petroleum Exporting Countries (OPEC) talks broke down without an agreement to raise output after Saudi Arabia failed to convince the cartel to lift production. Iran, Libya, Iraq and other oil-producing states wanted to hold production targets while Saudi Arabia sought to raise them so the price of oil would stabilize at between $70 and $80 a barrel. Wise, long-term-oriented Saudi government officials understood that stability rather than short-term windfalls is in the long-term best economic interest of oil exporters—especially if oil is the sole export. According to The Wall Street Journal, "In the wake of the failure to reach agreement, people familiar with the matter said the Saudis are now likely to unilaterally increase their own production by up to one million barrels a day, which would put them well above their stated quota of eight million barrels a day." The Saudi assurance that it would supply the needs of the oil market regardless of OPEC left investors bearish after the meeting, and short-sellers were simply unloading. To report that the price of oil “soared” by $2 after the meeting is utterly misleading. By the end of trading for the day, oil was up just $1.65 (at $100.74).

Even by Wall Street’s own mantra wherein investors tend to do well in the stock market by holding a well-diversified position for a long time, over-dramatic renderings of short-term changes are counter-productive because they can seduce long-term investors to react. If newscasters on CNBC are announcing that the sky is falling today because oil went up $2, the temptation is to do something.  Anything.  Acting at all would be at odds with taking a long-term position in the market, tweeking it only to maintain a diversified portfolio.

I suspect that cause of the hyperbole is tunnel-vision, which is caused by zeroing in on something too closely and for too long. At the very least, it might be a bad idea for Wall Streeters to develop some hobbies that have nothing to do with work. Also, analysts might avoid the temptation to pay so much attention to the talking heads on CNBC. Furthermore, analysts might resist orienting graphs to overplay small changes by artificially restricting the interval on the y-axis. Lastly, Wall Streeters might resist the fun in using overly-dramatic jargon or loose-fitting (at best) analogies.

If the stock market is “crashing,” for example, we had better be talking about thousands rather than hundreds of points lost on the Dow. A plane going from 12,000 to 11,500 feet is not crashing; it is probably just making way for another plane. If a company is getting “killed,” it better be in liquidation without anything going to equity or bond holders. Better still, analysts would gain credibility if they stayed away from the military jargon completely; at the very least, using the vocabulary is an insult to the brave men and women who really have put their lives on the line.

In short, Wall Street could do with a dose of perspective. Such a change would be in line not only with credibility and reputational capital, but also how Wall Streeters fare in the market. As one person might say to another who has been dumped romantically, don’t over-analyze it!


Sources:

Summer Said, Hassan Hafidh, and Benoit Faucon, "New Cracks in Oil Cartel," The Wall Street Journal, June 9, 2011, p. A1.