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‘Fake news’, social investing and the Herd Effect

Wednesday, 11th January, 2017 1:00am

Apparently, we are living in a ‘post-truth’ age. Social networks such as Facebook and Twitter have been associated with the dissemination of ‘fake news’. However, this is not necessarily a new phenomenon. Our thoughts and ideas have always been dependent on our interactions with other people. Irish people, in particular, like to talk about subjects that excite us, interest us and worry us. Our networks may have spread from the local pub to the virtual world, but social interactions have always mattered for investing and for economic behaviour.

Although politics dominated 2016, many of the issues that pepper our daily conversations are linked to economic and financial issues. Examples include the USC; how to fund the Irish health system; and the advantages of international trade. Several business channels, for example CNBC and Bloomberg TV, discuss nothing but these issues 24 hours a day.

Despite these media channels, human interactions still matter. A survey conducted by Robert Shiller (currently Chair of the American Economics Association and the economist who coined the ‘Irrational Exuberance’ phrase to describe the dot.com technology stock market bubble) indicated that 50% of wealthy investors became interested in a company’s share because another person mentioned it. In addition, Shiller found that since buying the share, each investor had spoken to an average of 20 other people about the firm.

Within an hour of watching CNBC or other financial news channels, you are bombarded with the notion that in investing, speed is of the essence. However, making split-second decisions after watching financial news may be about as rational as buying a ‘diamonique bracelet’ on Price Drop TV or a discounted watch on QVC. It is not investing; it is more akin to gambling and probably triggers the same emotional and biochemical reactions as the endorphin rush experienced by problem gamblers.

Media outlets race to be the first to report events as they happen. Investors then rush to trade on this news with a herd mentality. As you learn what other people think about various shares, a social consensus forms. As people act on this consensus, a herd forms. Investor herding is not unlike that of the antelope on the savannah. Antelope stay together in herds to protect themselves from predators such as lions. One minute the herd is doing nothing; the next minute the herd is in full gallop. An antelope’s senses are such that it knows what the herd is doing – it does not want to be left behind.

Investors also keep an eye and ear open to what other investors are doing. Many people watch financial news channels, follow online investment blogs, or follow famous investment gurus on Twitter. Active investors check their portfolios daily. The problem with moving with the herd is that it magnifies psychological biases. It causes us all to make decisions based on the herd’s emotions rather than on rigorous financial analysis. As many investors are influenced in this way, the herd can affect the overall market. The previously mentioned ‘irrational exuberance’ for Internet-related companies in the late 1990s is an obvious case in point. From mid-1998 to mid-1999, a total of 147 publicly traded companies changed to a new name with a “.com” or “.net” ending or a name that included the name “Internet”. During the three weeks after a name change announcement, these firms’ shares beat the market by an average of 38 percent. Even firms with little or no web focus changed their names and experienced large stock price gains. The dot.com obsessed herd bid up these share prices and these gains lasted for a number of months. Interestingly, after the technology bust in 2000, 67 companies removed the dot.com reference from their name. This reverse name change was then associated with an average 64 percent gain during the subsequent two months.

To conclude, people do want to talk about investing. The rising popularity of financial media and online investment discussions indicate how investing is now permeating daily culture. But this social interaction can lead to herding. Such herding typically does not occur because of new economies or new technologies; instead, it occurs because of the human psyche. New technology may only be the rallying cry for the herd.

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