STREET DOGS

The stock market is one of the world’s great aggregators of information. Scholars have been documenting its remarkable ability to sniff out and assess information about companies. Studies show market prices react to news with staggering quickness and tend to see through accounting conventions and subterfuges to the real economic value of a company’s earnings. So when a CEO argues investors are failing to give his company adequate credit it’s a safe bet the market is right and the CEO and his accountants are blowing smoke.

While public stock markets are often assailed for short-termism and impatience, there is ample statistical evidence that stock prices, especially for companies in the early stages of growth, factor in potential earnings decades down the road.

But there’s also evidence that investors’ willingness to look into the future is on the decline. And stock markets have never been infallible in their assessment of companies’ prospects. Financial markets need imperfection — “noise”, to use the term popularised by finance scholar Fischer Black — if they are to work. Black’s guesstimate is “at least 90%” of the time the prices prevailing on financial markets are “more than half value and less than twice value”.

Financial markets, the late economist Paul Samuelson said, are microefficient and macroinefficient. Using the right statistical tools, useful, rational signals can be separated from the market’s noise. But if you look at what your company’s stock did today, or even this month, you are likely to see hyperactive chaos. Human nature dictates that more attention is given to simple recent signals than to complex long-run trends, especially when we are paid to give attention to them.