What lesson can investors take from the Wikileaks data dump?
In one sense, the Wikileak's publication of State Department cables is a grown up version of a kid who has posted all of a popular peer's secrets on FaceBook. Obviously the stakes are much higher, but one word that might capture the sentiment: AWKWARD. The takeaway relates to a lesson I learned as a grade schooler; assume anything you commit to writing will be read by everyone. I learned this the hard way as I gained some notoriety among my peers for making characitures of my teachers (and was eventually busted by my 8th grade science teacher - ackward indeed). After I was caught, my father instilled me with the wisdom of about never putting certain things in writing.
Today political players around the world are digesting this deluge of data. Feelings are hurt, sentiment sharing will be deep-sixed, and State Departments around the globe are positioning themselves for how to deal with the inevitable controversies around the dynamics of he-said-she-said. Regardless, the risks of making sub-optimal decisions (i.e. overreactions) based on TMI (Too Much Information) exists.
Between a multitude of television programming, news outlets, and blogs, today investors too are submersed in an age of information where data is spun into commentary at just about every turn (yours truly included). Thus, investors have been at risk of making sub-optimal decisions based on TMI. I often think of relatively aggressive investors who become conservative at the peak of crisis (when the news the worst and doomsayers reign) - or visa-versa - only to capture more downside than up.
Perhaps one of the better weapons to handling TMI comes from the concept of "Intelligence Hierarchy" as highlighted in Barry Ritholtz's blog yesterday - where data transcends information, information can yield knowledge, and knowledge can bring wisdom. In my opinion the proportion of investment data and information at arms reach outweighs knowledge and wisdom by about 10-to-1 (which is consistent with the pyramid diagram of the subject). A good exercise might be to make a casual observation of this the next time you flip on your favorite business channel.
Further, this is why it often pays to listen to those who speak from a position of wisdom. When someone like Warren Buffett comments on the market or investing in general, for example, I typically observe more wisdom than data. Quips like "be greedy when others are fearful and fearful when others are greedy" exemplify this.
Another bit of wisdom I've come to embrace is that investors (and people in general) respond to incentives. This helps to explain, for example, why gold remains at relatively lofty levels. With zero-range interest rates (after inflation), the only incentive to put assets into money-markets or Treasury bonds is safety. However, most investors want more than a 0% inflation-adjusted return. Combine this with a fear of inflation, and there is a pretty good incentive to own gold (I don't own any, but understand why one might).
The wisdom of incentives also explain why deeply-discounted or higher yielding investments (especially when adjusted for risk) tend to outperform in the long-run. For example, when you can buy a company that earns $10 for every $100 you invest, you have a greater incentive versus a company that earns only $5 for $100 invested. This is exactly the difference between a company with a price-to-earnings (P/E) ratio of 10 versus 20. These incentives often lie deeper than the data at hand. While the news and information (the story) may be more appealing for the company with a P/E of 20, investing in the other company may be more profitable (and wise) when the story turns positive and incentives gleam.
Consequently, while TMI may be a sign of the times, the burden is on investors and politicians alike to seek wisdom.
Jack Brown, CFA