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The Media Has Failed Us

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Financial media is not helping us become better informed or better investors. These outlets devote too much of their airtime to forwarding partisan propaganda rather than informing or entertaining us. The numbers suggest media is actually misinforming us and turning us into bad investors.

The findings of a recent study, Misinformation and the 2010 Election from the University of Maryland's World Public Opinion, show that 9 in 10 voters in the 2010 election believe they encountered information that was misleading or false, with 56% saying this occurred frequently. The study also concludes that those who watched Fox News almost daily were significantly more likely than those who never watched it to believe misinformation.

The bad news for Fox News viewers is that merely watching the channel appears to be toxic. Most voters believed a few whoppers during the 2010 election cycle. But daily watchers of FOX News believed more misinformation than everyone else.

Numbers Don't Lie

The majority of retail (casual) investors use mutual funds and ETFs (Exchange Traded Funds) to invest in the markets. Fund flows (deposits vs. withdrawals) are generally regarded as contrary indicators. This is a component of a broader series of indicators classified as investor sentiment that provide some insight into future directions of the market. The basic principle being that when many investors are bullish the market is more likely to go down and conversely a higher level of bearishness or negative sentiment indicates the market is likely to make a move higher. TrimTabs Investment Research reports on these fund flows and in a recent report stated:

We observed that equity prices tend to fall after equity exchange-traded funds (ETFs) rake in large sums of money. Conversely, the market tends to rise after equity ETFs post heavy outflows.

The report then issues this conclusion:

We have two explanations for the strongly negative correlation between equity ETF flows and future market returns. First, ETFs are traded mostly by retail investors and day traders. These are the least informed and most emotional market participants--the ones most likely to lose money over time. Second, we suspect hedge funds use ETFs when liquidity dries up. Hedge funds were forced to close individual stock positions during the credit crisis, so they bought equity ETFs instead. Equity ETFs posted large outflows in 2009, when liquidity improved.

These concepts are not really as complicated as they seem. It's Economics 101. When demand outstrips supply, prices go up and when supply is larger than demand, prices go down. When funds are flowing into stocks, markets rise; but at some point most people are invested and there isn't enough uninvested capital left to drive prices higher.

Whatever the internal dynamics, the retail investors are generally the last to join in a rally and their main vehicle of investment are mutual funds and ETFs so large inflows into those instruments suggests that the market is near the top. That's how many retail investors get the timing wrong and end up losing money. Nobody likes being wrong or losing money, it makes us feel pretty lousy and reluctant to invest, starting the whole cycle all over again. This is borne out in the current rally where the retail investor is reticent to return to the markets after being burned so badly in the housing/banking crisis of 2008 - maybe one time too many in the last decade. As a result they'll probably join in just as the rally is about to top out. As Adam Shell recently wrote in USA Today:

Yet, increasingly, investors on Main Street are not playing the stock market game with confidence like they used to, mainly because the game of making money has gotten tougher and more volatile since the financial crisis. Retail investors are buying fewer stocks. They are paring back on stocks and stock funds they already own. Instead, they're moving into safer investments, like cash and bonds.

"Investors are on strike," says Axel Merk, president and chief investment officer at Merk Mutual Funds.

Investors Should Turn Off Their TVs, Not Stop Investing

With the proliferation of financial media and its informed commentary I would hope investor habits would be improving. But the numbers tell us they aren't. The media is in fact complicit in perpetuating the retail investor's position as contrary indicator, often referring to those contrary data points in assessing the market's direction.

In Rick Santelli's famous rant on CNBC he called overburdened home owners struggling with their mortgages "losers" while using his podium to forward his political agendas. He is now credited with being the "lightening rod" of creation for the Tea Party movement. Perhaps he should have used his obviously influential media position to warn people of the perils of the housing bubble, helping them avoid complicated mortgage products that are hard to manage financially in the downturn that many market observers were predicting. Although I don't blame investors for turning away from the markets after such treatment, it is the wrong decision.

Markets have historically been a better investment than many other asset classes with the S&P 500 returning roughly a 7% annual rate of return. Stocks should, at the very least, be a strong component of a diversified portfolio. Instead of shying away from being burned again, investors should examine unsuccessful behavior, eliminate negative influences and improve decision making.

Investment Principles for Profitable Investing

Tune out the noise. Lengthen your investment time horizon. Never feel like you are missing out on a rally. Don't panic in a selloff. History is your friend. Buy low and sell high so you can turn off your TV set to pursue activities you enjoy.

I hope technology positively affects your life in 2011 and all your investments are winners.

Follow Steven Bulwa on Twitter at @BulwaTech.