E-motions: Vol. No. 1, Issue No. 2, August 1, 2005

Nervous Investors Associate Stocks with Information from the Front Page

1. Emotions in Focus: The Power of Associations
     Many experts tell investors to look to the news in order to price a stock or to better understand the future direction of the market, but the amount of information available is too vast to systematically analyze. Furthermore, many important investment decisions are made by people who are very busy with other careers, or by professional investors, who have to make a great number of trades quickly and often have to make snap decisions. This is especially the case at critical times on the market, such as when earnings reports have just been released, and stock prices have the potential to either sky rocket or plummet within the day. The so-called "rational" strategy, given these circumstances, might be to turn to a trusted professional who can provide an appropriate volume of pre-analyzed, organized information about the fundamentals of a company. This approach, however, is often not how nervous individuals make decisions.
Sometimes different trusted sources may produce conflicting information. Other times, people do not even know where to look for such expert advice, and they cannot spare the time to search for it. Moreover, conducting systematic research is not their first instinct when important financial decisions must be made in a short period of time. Instead, people use their emotions, what feels intuitively correct right, or whatever idea first pops into their heads. According to social psychologists and market researchers, people may rely on these factors because snap decision-making once was adaptive for humans, in that if it is easier to make decisions quickly, then people can get on to the next problem at hand, and they have a better chance of survival. While there are still some cases where this sort of emotional quick thinking is still adaptive, it may not be the best way to buy and sell stocks. Nonetheless, people still often trade emotionally, so it is important to understand the mechanisms behind it.
In particular, what often helps people make snap decisions may be how familiar a concept sounds, which in turn makes it appear more trust worthy and important. Having heard or seen something before, even if the individual does not remember the source, can not only make something seem more familiar, but also more believable and important. Beyond a sense of familiarity, the nature of people's primary associations with a concept, or, in this case, a company, can determine how they in turn view the concept or company.

2. The Big Movers and Why
     Understanding the context in which the media mention a company or sector can be critical. For instance, last week the aerospace and defense sector, in general, did very well. This movement is not surprising, as America, and increasingly, the rest of the Western world's, need for strong defense keeps on growing. Most recently, there was little hope of the war in Iraq de-escalating after last week's terrorist murder of two Algerian diplomats. Overall, it was obvious to investors to move into the defense sector, but in terms of which individuals stock picks to make, the Middle East war and terrorism headlines were not enough information with which to narrow down their choices. As quarterly reports came out for many of these companies last week, investors were left to decipher earnings and profit statements, searching for the best picks out of a larger pool of overall-favorable reports in the defense sector.
Here the vital role of the popular media emerges. Instead of looking at the earnings reports available to explore the defense sector, it appears as though investors relied upon associations they had between particular companies and stories from the top of the news. MediaSenitment Heads Up rated two stocks in the defense industry reporting earnings last Tuesday, and found highly positive sentiment in both of the reports, giving them all a thumbs-up recommendation. Out of these, one was a big mover, indicating that it not only experienced significant movement on the market, but also sparked a strong emotional reaction in investors through the media. The other stock just went up 1% of its total value. The first company, Crane Co. (ticker: CR), up 14.08% on Tuesday, in its earnings statements and press releases at the beginning of the week, largely billed itself as defense contractors, playing into top news stories about continued war in Iraq, terrorism in Europe, and new demands form North Korea on the US. Thus, to an investor skimming the report, words like "military" or "Department of Defense" would refresh the reader's memory about what he or she had seen on earlier on the front page of the morning paper, and the message of the story, that strong defense is the need of the hour, would translate into greater confidence in the success of the company whose earnings report he or she had been reading.
The second company, Carpenter Technology Corp. (ticker: CRS), while it went up a meager 1% on Tuesday, was down again on Wednesday and again on Friday. It continued to show much greater volatility throughout the week than Crane Co., which stayed strong through Friday. While in profile, Carpenter Technology has analogous clients and products to Crane Co., it focused, both in earnings reports, and press releases, on its role in space research, rather than defense. Carpenter Technology's report came out around the same time of the morning on Tuesday as many papers and other news sources ran stories regarding concerns about the potential failure of the Discovery space mission, and the previous failure of the Challenger mission. Thus, when investors read information about Carpenter Technology's involvement with aerospace, their first association was "disaster". While the stories about the tragic deaths of astronauts likely had nothing to do with the profitability of the company, the negative associations made investors nervous, so the stock did not go up as much as it might have otherwise. Then on Wednesday, with news of the Discovery space shuttle being damaged during its launch, investors had even more negative associations with the company, and the stock price went down. The resultant nervousness on the part of investors and doubts about the future of the NASA space program likely sent the price of the stock up and down the rest of the week.

3. How to Make the Most of the News
     When making your own tough decisions on the market, it is important to understand the power of the associations we make between investments and messages from the media, even when that information may not be the most relevant or credible. Even professional traders start to rely on popular media when they are trying to predict the behavior of others. In finding the "greater fool", traders attempt to determine how other people feel about a given stock, and if those investors be willing buy it for even more money than the traders are currently willing to pay. Often, after traders have read analysis from experts and poured over earnings reports, a large part of the assessment they make about the behavior of others involves looking to the forms of popular media that reach the most consumers.
Overall, even if investors are not willing to admit they trade on intuitions, they do often go with a company or sector that they associate with familiar information and positive concepts that they have seen or heard elsewhere in the news. Conversely, an association between a stock and a negative front page news story that is even remotely related to the company can make investors shy away, even if a company has positive earnings reports. Realizing that other investors rely on associations between financial information and sentiment from the mainstream news to make decisions can be an important predictive tool. Additionally, knowing about this sometimes unconscious process of evaluating information can alert the individual investor to when he or she may be making an irrational financial decision. Overall, knowing the direction of public opinion in the mainstream media is a solid strategy for predicting when investors will get nervous, and how they will react to the market and information about companies.

4. Last Week in Media Sentiment
     In terms of the strength of this kind of analysis, last week's correlations between MediaSentiment.com's thumbs up / thumbs down recommendations for Heads Up rated companies and subsequent stock price show a powerful relationship. The correlation between ratings for MediaSentiment.com selected stocks and their highs and lows the next day is 87%, explaining a majority of the variation in highs and lows. Therefore, this week, MediaSentiment gave an 87% edge to smart investors who used Heads Up recommendations!
All figures reflect all MediaSentiment Heads Up recommendations for the week of July 25, 2005 through July 29, 2005, rating companies on the day of their quarterly earnings releases correlated with their stock highs, lows, closing prices and daily volumes for the subsequent day.

5. Links You Can Use

NASA workers getting that old feeling

L-3 Communications Profits on Defense Spending

The Powers and Perils of Intuition

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