April has been quite a month filled with steep ups and downs. At this point, we are all aware of the catalysts; on-and-off tariff threats, the prospect of trade wars, DOGE impacts, firing-or-not firing the Federal Reserve Chairman. There has been a lot of turmoil in the past few weeks that hit the headlines. This may have been too much for investors attempting to boil down potential outcomes of these on-again, off-again headlines subjecting the stock market to some wild swings.
The breakneck speed between an announcement and the stock market reaction was mesmerizing. The stock market was influenced more by the headline rather than the actual policy impact. In fact, companies’ earnings do not respond to any obstacles within minutes of being broadcast. Though not normal, it is not uncommon either for stocks to react to headlines in such a sporadic fashion. This is referred to as headline risk.
Headline risk is the possibility that a news story will adversely affect the price of an investment, such as a stock or commodity. Headline risk is mostly associated with individual stocks but can impact sectors more broadly or, on occasion, the entire stock market.
Suppose that an automobile company announces the development of a new engine with no emissions, minimal cost and varied applications (cars, trucks, semi-tractors, farm tractors, etc.). In response, the automobile company’s stock would soar with competing car companies’ stocks dramatically declining… even though it would take 30-60 months to be placed into production. This is an upside and downside headline risk in the same news item.
This happens because equity investors are quick to guess at extreme possible outcomes without evaluating probable impacts or a reasonable time horizon. Headlines generated by newspapers, television, or online have a wider impact potentially moving the entirety of the stock market. Note that prices can move even if the story is incorrect or misleading, although in such cases the prices will tend to snap back.
Such environments can be tricky and harrowing. Tricky from an investment standpoint attempting to assess what is reasonable vs. what is bluster. Harrowing to individuals not used to such changes; especially to those that assume the stock market is always a logical cash flow discounting mechanism. There are times when the stock market does not act rationally. The last few weeks have been one of those times.
The first defense to headline risk is diversification. Broadly diversified portfolios fared better than concentrated to narrowly focused portfolios. Second, recognizing irrationality does enter the stock market, yet the irrationality adrenaline hit will ultimately subside with more frontal lobe reasoning. Lastly, it is best not to get too wrapped up in the minute-by-minute news cycle. Just wait, and the headline will change. Clearly, there is a uniqueness to the recent weeks, but markets have seen irrational anxiety before.
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