Private BankingSeparating Signal From Noise

Bruce SimonAugust 2015

At City National, we believe that perspective is one of the most integral foundations of investing. It takes experience to perceive markets at the right distance. Short-term volatility can lead to myopic irrationality, and create misleading noise for market observers and investors. Long-term strategies can run the risk of ignoring valuable signals that might otherwise be used to inform decision-making.

Discerning the signal from the noise is one of the greatest values we bring to our high net worth clients. We avoid reacting to market hype and common short-term overreactions and tailor each perspective to fit every client’s unique needs.

At the end of last year, we predicted that 2015 would be another successful year for equity investors, but cautioned that gains would be hard-fought and accompanied by significant turbulence along the way. We thought that investor patience would be tested by the onset of higher interest rates in the U.S. and continued economic struggles among the world’s other major economies. While the story for the year remains to be told, the turbulence has returned as expected.

[To read more of Bruce Simon’s thought leadership click here]

“U.S. Stocks Fall Amid Concerns About the Deepening Greek Debt Standoff” was the headline in a news article last month. Sounds pretty scary. The very next day, a market recap was titled “U.S., Europe Shares Rise with Greek Bonds on Signs of a Debt Deal.” These head-snapping changes in seemingly important stories are enough to give investors nausea, and are certainly contributing to this year’s stock market roller coaster ride. Short-term myopia is driving asset price performance, and, to those only attuned to the market for intermittent periods, the context seems entirely unpredictable.

We believe that any attempt to derive actionable insight from the market begins with the understanding that financial asset prices are driven by three main factors: fundamentals, valuation, and psychology.

When it comes to stock prices, fundamentals refer to the future earnings growth of a company, and are dependent upon many factors – both internal (e.g., business strategy and execution) and external (e.g., macroeconomic) to the company’s operating environment.

Valuation is a process that attempts to identify whether an asset is overvalued or undervalued relative to its future earning power, past history, or other companies in similar businesses.

Psychology is the short-term “noise” that tends to create mispricing opportunities when investors overreact to the market-moving news of the day, and is heavily influenced by investor mood, or sentiment.

In our view, investors should gauge the impact of daily headlines on each of these three factors. A perspective that is too near to the headlines du jour may ignore valuation and fundamentals, whereas a perspective that is too distant may ignore the useful context that these factors may provide. There is noise in the news, certainly, but there are valuable signals, too.

Understanding any scenario in the context of these three factors can help isolate actionable signals. One could construct a scenario in Europe that involves Greece defaulting on its debt, exiting the Eurozone, and opening the door for other larger countries to follow suit. This would have a devastating effect on European fundamentals and would undoubtedly impact other equity markets outside of the Eurozone. We assign an extremely low probability to this outcome, and therefore view most of the headlines coming from Greece to be noise, and impacting investor psychology more than anything else.

[For more on City National Rochdale’s approach to Private Banking click here]

How does our interpretation of the signals translate to our outlook? We continue to view both market fundamentals and valuation levels as reasonable and supportive of higher stock prices. While the precise timing of the Fed’s first rate increase is the subject of endless speculation in the financial press, looking back three years from now it likely won’t matter much whether the first rate hike was in September or December of 2015. More important than the exact timing is the pace at which the Fed raises rates, and the subsequent impact on the global economy. The depth of the economic impact is likely to have a far greater effect on fundamentals and valuation than the timing of the decision.

Successful investing involves distinguishing the signal from the noise. At City National Rochdale, we manage client portfolios with the philosophy that all news and current events are worthy of consideration, but not all are worthy of action. It’s this perspective that enables us to focus on events that are likely to shape long-term trends, and to build your portfolio on the tangible, not the ephemeral.

For more information about working with City National Private Client Services or City National Rochdale, speak with your financial advisor, or visit cnb.com to learn more about our Wealth Planning Solutions.

 

Non-deposit investment products are not FDIC insured and are not bank guaranteed. Investing involves risk, including the loss of principal. Past performance is no guarantee of future performance.

Bruce Simon