Word bubble: The kinks of financial journalism
A decade on from the 2008 financial crisis and amidst the current crisis of confidence affecting many emerging markets its worth revisiting how markets of all sorts (not just commodity markets) are represented in the financial media. Recent research has identified the choice of words used in the financial media as being an important factor that can be both used to identify peaks and troughs, but may also influence investors expectations of future returns too.
The financial media, like individual investors and pundits, reflect a collective mood regarding the state of the market. In theory, the relationship between word choice and the markets should be linear. Taking equity markets as an example, the higher markets go, the more positive the language should become. Conversely, when markets fall, the language should grow more negative. This was the message from earlier research from the economist Robert Shiller, who explained in his book “Irrational Exuberance” that the media tend to exaggerate average days, hyping up stocks on very strong days, as much as they overdid the gloom in bad times.
A paper published in 2017 by Diego Garcia of the University of Colorado, entitled “The Kinks of Financial Journalism”, shows that, at least based on word choice, this relationship does hold, but only up to a point. As the title of his paper suggests, what Professor Garcia found was that market reporters tended to be asymmetric in the way they report market moves. The media are more negative about market falls than they are positive about market rises. As markets rise above a certain point or for a certain length of time, they reach a “kink” in which higher market highs made little or no difference to the positivity of journalists’ prose. However, as price falls grew worse, the language grew ever more negative.
The methodology involved searching through a database of financial market stories published by the New York Times and the Wall Street Journal between 1905 and 2005. The researchers assigned a score to the choice of words on a scale from positive to negative and then analysed how the positivity and negativity of coverage correlated with moves in the Dow Jones Industrial Average (DJIA). While the DJIA does not represent an average investor’s portfolio by any means, and is a measure of equity markets rather than commodities, it is reasonable to assume that the language of financial media reporting is similar across different asset classes including commodities. The caveat being that the price of commodities depends on the context, for while investors in oil companies may like higher oil prices, major energy importing nations will not since it could be a drag on economic growth.
As markets rise, investor confidence increases. Unknowingly, this higher confidence triggers perceptions of greater certainty and control among the media and investors alike. Cognitively, the brain is at greater and greater ease and rational thought takes a back seat. As a result, with things going well, we require little third party explanation or validation. Good times don’t need a story, let alone encouraging and positive language. There is little the financial media can or need add to the cognitive sensation that good has become better and the only way is up. For investors, the fact that the market was up and then up some more is itself self-affirming. Inherently investors want rising markets to be normal. In fact, ideally, rising markets should be so normal as to be altogether “un-newsworthy”. So, after a few days, there is remarkably little for the media to offer.
Falling markets, however, are a very different story. As markets fall, investor confidence decreases. Cognitive strain quickly develops and, as a result, narratives become vital as investors seek out reasons to be confident. Ironically, the media rarely offers that. As the media reflects the same falling mood and growing uncertainty as its followers, its own articles and stories become more negative as market prices decline. As peculiar as this may sound, by growing more and more negative the media is affirming that investors are correct in their feelings of uncertainty and being out of control. The lesson for investors and physical buyers and sellers in commodity markets is to recognise the change in the language used as a means for spotting euphoria and despair.
Another paper (“Mining the Web for the “Voice of the Herd” to Track Stock Market Bubbles”) by researchers from Trinity College and University College (both based in Dublin) also confirmed that language is important. They found that changes in the frequency distribution of English words can be helpful in identifying stockmarket bubbles. The researchers looked at thousands of articles from the Financial Times, the New York Times and the BBC that were published over a four-year period starting in 2006. They found that journalists’ language became less diverse when stockmarkets were rising, with certain common nouns and verbs like “rise”, “fall”, “close” and “gain” becoming more common still. The same does not apply when markets are falling: then, journalists’ language becomes less homogenous.
According to the Financial Times journalist John Authors, the financial media is exposed to asymmetrical incentives. The media are affected by “what might be a variation on what is known in the behavioural finance world as ‘loss aversion’.” The financial media, reflecting the fears of investors, are horrified at the prospect of losses and reflect this in their reporting. Authors also believes that there is a bias in favour of caution and negativity:
“For market journalists it means that we are far more scared of encouraging readers to buy and ushering them into a loss, than we are of urging them to be cautious, and thereby leading them to miss out on a gain. I hate the fact that I have been incorrectly bearish many times over the past eight years. But I am still deeply relieved that I was correctly bearish ahead of the disasters of 2008.”
The two-way connection between investors and the media creates a feedback loop whereby downward market movements may become exaggerated, amplifying the impact of the initial shock. This potentially opens up opportunities for investors who can spot when the media narrative has become too negative and so prices may not reflect the strength of the underlying fundamentals.
Although paying too close attention to financial media has its downsides (information overload for one), it may also pay to listen to the voice of the herd, particularly the choice of words.
Originally published on Materials Risk here.