Market Rationality and the Digital Age

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With so much information available to investors today, you might think that markets have become more rational states Institutional Investor. But in fact, equity markets are as emotionally charged as ever – maybe even more so. In a short-tempered world, patience and human judgement are becoming more important than ever.

Equity investors today face an unprecedented flood of information. Yet the deluge of data hasn’t made markets more efficient. The research¬†shows that U.S. stocks have been reacting more sharply to earnings surprises since 2000 than they did in the previous 13 years. Even with HFT machines that capture every possible opportunity by the millisecond, behavioral biases have intensified.

As a way to overcome the information overload, a classic value investing approach could be used to exploit the short attention span of the digital age. In an effort to identify stocks whose recovery potential is being overlooked, value investors should primarily look for companies that have been hit by an overreaction to bad news. It’s a discipline that relies on research that¬†focuses on fundamental drivers of earnings and returns and on assessment of recovery potential.

However, finding cheap investment candidates with significant recovery potential requires experience, historical perspective and the patience to look at a company in controversy and develop a conviction that a different future is possible.

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