HOW NEWS AFFECTS THE STOCK MARKET

A significant aspect of news is the way in which it affects the capital markets. The news that the chairman of the Federal Reserve Bank publicly suggests that there are signs of economic recovery reflects almost instantly in the stock market. The market reacts when the U.S. Food and Drug Administration approves a drug, and when an airplane manufacturer gets a major contract. It reacts when an audit fraud is uncovered, and when a company has a research breakthrough. And the market seems to react to every election, regardless of which party wins, and to wars, and to violent weather in a bread basket area of the country. The stock market, reacting to the news of the day (or more appropriately, the news of the minute), can be a nervous cat.

The market certainly reacts to an event, and to the news of it. The financial chicanery of the Enrons and WorldComs, the failures of the accounting profession and the dramatic demise of the giant accounting firm Arthur Andersen, were a reality of inevitable newsworthiness. No investor relations or public relations professional was necessary to get those stories in the paper. But not all business news is as substantial as these great disasters. There is lesser news that is consequential to the dynamics of the financial markets. The difference is that in dealing with financial media, this lesser news must sometimes be made clear to editors in all media, who might not readily understand the relationship of the news to the investment decision. Therein lies the role of the investor relations communicator.

One thing is certain, then. The market—the stock market as well as all other money markets—does respond to news.

In their classic book on the subject, News and the Market, Frederick C. Klein and John A. Prestbo, two Wall Street Journal reporters, explored that relationship in great detail. They say, “It certainly makes sense to believe that the stock market responds to the news. Movements of the market as a whole and of the stocks that make it up spring from the decisions of thousands of investors. These people, be they steely-eyed fund managers on Wall Street or little old ladies in Dubuque—read the newspapers, watch television and so on, and presumably are affected by what they see and hear. If the United States economy seems to be functioning smoothly, it stands to reason that they will feel well disposed towards sharing in the bounty. If the opposite conditions obtain, a bank account or hole in the ground might seem more secure.”

In his very popular book, A Random Walk on Wall Street, Princeton Professor Burton Malkiel covered many theories of stock market analysis and relates virtually all significant stock movement to news. Both books deal with time lag—the time between the reporting of news and the reaction to it in the stock market—an extremely important factor. The company issues a quarterly release that shows earnings lower than those of the same period for the prior year. The stock shows no motion or perhaps even advances a little. This frequently means that the market has anticipated the reduced earnings and sold off in proportion to them, or that the reduction is smaller than had been anticipated and that other events, or a new outlook, warrant stock purchase. The important thing is that all segments of the capital markets, from the individual investor to the manager of a major fund or trust department to the lending officer of a bank, are responsive to news.

Malkiel dealt with the efficient market theory, a basis of which is that the entire market is privy to the same information and so reacts accordingly as one. Critics point out, however, that the market isn’t universally privy to the same news, particularly in smaller companies (which is why we sometimes have a two-tier market), and not everybody interprets the same news in the same way (which is why we have an auction market). With the vast array of sources of data—company, industry, economy, and so fourth—efficient market theory is diluted by those who access the news. This is both a potential weakness in efficient market theory, and an opportunity for the investor relations practitioner. The company that explains itself best to investors is the one that wins the competition for investment capital.