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July, 201810:46 PM



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Market News - Is it "Noise" or "Signal"

Market News - Is it

By Bob Kohut 20.02.2017


How does a retail investor differentiate between useful and useless information about a given stock?  To a large extent that depends on one’s investing approach.  Some experts like to differentiate between “traders” – those looking for short term profits – and “investors” – those looking for long term wealth building.

Suppose the morning financial news includes a piece about changing economic conditions in a given country where Company A derives the majority of its revenue.  For traders, this information is “signal”; a useful indication the price of the stock is likely to fall in the short term.  For investors, the information is at best not helpful and at worst useless since the impact has yet to be seen.

The concept of “noise” in markets was first introduced in a 1986 paper in the Journal of Finance by economist Fischer Black. Black categorized noise as information that hasn’t arrived yet -- simple uncertainty about future demand and supply conditions.

This view provides the average long term retail investor with a helpful “filter” to be used to separate noise from signal.  To illustrate we will take a stroll back in time to examine two stocks that both spent considerable time on the ASX Top Ten Short List -- Cochlear Limited (COH) and JB HiFi Limited (JBH).

Short Sellers have earned a reputation as careful researchers, simply because they have to be.  Shorting is betting the price of a given stock will go down, with the short sellers making a profit on the difference between the price at which they shorted the stock and the price at which they actually bought the shares.  In effect, shorts “borrow” shares of a company to be paid back at a later date.  If the stock goes the wrong way, the potential loss for a short seller is infinite.  Going long on a stock at $10 per share caps the potential loss at $10 per share should the company go into bankruptcy.  Shorting that same stock at $10 opens the door to unlimited losses should the stock price keep climbing.

On 9 September of 2011 shares of Cochlear reached an intraday high of $74 at the close of the trading week. On the morning of 12 September the company announced a voluntary recall of its flagship product, sending the share price plummeting more than 20% with short sellers piling on. The following price movement chart from late March of 2015 shows the immediate impact and the ultimate recovery.  


Shares of Cochlear are now trading around $135, an increase of more than 130% since the 2011 fall.  At that time short sellers and some investors saw the information in the recall news release as a signal to sell. Analysts and industry experts predicted the company would lose market share due to its diminished reputation as the industry’s best.  Doctors, it was said, would begin looking for alternatives.  

To long term Cochlear investors the information could have been considered noise, as there was no immediate impact.  In effect, both the shorts and the longs interpreted the information correctly, depending on the holding period.  It was two years before the stock price recovered, allowing time for shorts to cover at a profit.  Longs with the patience to await actual results have been rewarded.

JB HiFi Limited (JBH) provides another example.  The stock fell out of favor as its reputation as Australia’s electronics discount king was increasingly challenged by severely discounted offerings from offshore online sellers, along with declines in the retail sector generally.  The share price erosion was gradual, as seen in the following price movement chart from late 2014.


In late November of 2012 the company announced its entry into “white goods” – homewares centering on large and small appliances.  For some investors the information in that news release was a signal to buy.  Others deemed it noise as the success or failure of the move was yet to be seen.  In truth, the real signal did not become apparent until the first release of information about revenue generation from the new line, which ultimately drove the stock price upward again.

The current ASX Top Ten Short List contains at least two stocks where the stock price over the past year appears to have been driven by information characteristic of both noise and signal. 
 
Aconex Limited (ACX) began as a web-based procurement management system for the construction industry and grew to its current state as a top provider of a cloud-based platform allowing collaboration of all phases of major construction projects.  The company does business in over 70 countries serving mining and energy projects as well as infrastructure.

Aconex debuted in December of 2014 with an issue price of $1.90, closing its first day of trading at $1.80. Lofty expectations, considered noise by some, plagued the company even before the listing as the expected amount of the capital raise was lowered with the issue price scaling back to $1.90 from the original plan for issuing at $2.20.

The less than an all-out bullish response to the IPO did not prevent the share price from climbing to around $3.24 by June of 2015.  A little more than one year later the stock price hit its all-time high of $8.53 in late July.  By November of 2016 the stock price had fallen into the $4.00 range.  Here is the price movement chart for ACX since it began trading on the ASX.


Aconex had released a string of positive news announcements, including solid Full Year 2016 Results released in August. Was the drop in price following the results release driven by noise, signal, or a little of both?  

Hot stocks like Aconex frequently get ahead of themselves, buoyed by market enthusiasm for a bright future that is yet to come.  Profit-taking and cautionary analyst comments about valuation can be considered useful information, causing investors to sell or at least monitor the stock carefully.  However, two events that sent the stock reeling are questionable. 

First the company’s CFO resigned amidst rumours about accounting practices at the company. 

Second, company insiders sold some of their holdings.  In the vast majority of cases, insider selling is strictly noise.  Insiders cashing in some of their hard-earned stock options are not an indication of trouble in the company, with the key word being “some.”  Short of a stampede of insiders selling all they own, the transactions do not alter the fundamentals of the company in any way.  Accounting practices that could lead to earnings restatements may be noise should they prove false.  However, many investors would consider the possibility of restatements useful information in determining whether or not to sell the stock or wait for further signals before buying.

On 30 January the information released by the company downgrading both its revenue and profit forecasts for 2017 could have been viewed as the ultimate signal to stay away, at least for a while.  However, enough investors appear to remain unconvinced, given the fact the stock price has rebounded substantially in the last few weeks

Syrah Resources Limited (SYR) is a graphite miner with the potential to become the biggest graphite miner on the planet, according to some industry observers.  Graphite demand is expected to boom with increased demand for electric vehicles and other applications for battery technology.  

Companies like Syrah that have yet to generate any revenue often flood market participants with a string of news that is not always useful for investing purposes.  However, news of successful capital raises is a signal of strong market sentiment.  Announcements of “offtake” agreements, which are contracts to purchase future supply once mines become operational, are definitely useful as indications the purchasing company has faith in the miner.

Syrah released announcements of both in mid-2016 and the share price climbed.  Here is the chart.


Following the dramatic rise, concerns about the outsized price appreciation set in, fueled by some negative research appearing in the US, where the stock trades on the Over the Counter Market.  In October investors reacted to the news of the resignation of the company’s highly regarded managing director and the price took a major dip.  

Management changes sometimes propel a stock price into a holding pattern.  This information can be useful but is not always transparent.  If there is trouble in the company, changing leadership could prove to be a good thing in the longer term, but in the short term the stock price drops, as market participants tend to “shoot first and ask questions later.”

In Syrah’s case, the market “shot” and the stock price decline continued until the December news the company could be a takeover target, lifting the share price in the hope of a bid higher than the depressed share price.  Certainly the information was useful for short-term traders but in the long term had no impact on the company’s mining operations, set to commence later in 2017. Once the takeover “noise” subsided, so did the share price.

On 7 February the Sydney Morning Herald, and other sources, reported that Credit Suisse had raised its 12 month target price on SYR to $7.80.  With the stock now trading at around $3.24, hitting the Credit Suisse target would amount to a 144% increase. That kind of information is useful for any investors considering buying the stock or adding to their holdings.

Despite its presence on the Top Ten Short List, Syrah Resources has a consensus Outperform rating, with 2 brokers with a Buy recommendation; and 2 at Hold. Aconex also has a consensus Outperform rating, with 1 broker with a Buy recommendation; 5 at Outperform; 3 at Hold; and one at Underperform.

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