How to deal with noisy markets

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The writer is senior adviser at Engine AI and Investa, and former chief global equity strategist at Citigroup

Market noise has dialled up to 11 as global equities have raced to price in Donald Trump’s sweeping election victory. Bank share prices are up. Alternative energy stocks are down. Some of these moves will be justified, some will not. Only time will tell.

It seems like a good time to revisit a common skill among the most successful investors I was lucky enough to meet as a sellside strategist. They were all very good at tuning out market noise. 

They did this in a variety of ways. One of my favourites was a pension fund veteran who kept every copy of the Financial Times from the past 12 months in a pile on his desk. Each day, he would read the latest newspaper and add it to the top of his stack. Next, he would pull out the bottom FT from a year ago, read it, then bin it.

Why? He argued that if a theme or event was in the FT today and a year ago then, by definition, it wasn’t noise. We would subsequently discuss how he could integrate that theme into his portfolio.

I often pointed out the obvious weakness in this strategy. He would be too slow to latch on to the next big theme. But he thought that was a price worth paying to avoid being bluffed into chasing market moves that didn’t persist.

This client retired many years ago, but I often wonder how he would be thinking about markets during periodic bursts of noise. Which themes would he be ignoring right now? Which would he be integrating into his portfolio? That’s easier to check in this digital age — no need for a pile of old newspapers.

Right now, he certainly wouldn’t be chasing the hot Trump trades. Instead, today’s FT would go on top of the pile. He would re-read it in a year’s time, along with his November 2025 copy. Only then would persistent Trump policies be integrated into the portfolio. It would be the ultimate “see what Trump does, not what he says” strategy.

Alternatively, he would have bought into the AI-related tech stocks last November (a year after ChatGPT’s launch). There are few signs of the theme fading from the headlines, so he would not be inclined to cut his positions yet.

This eccentric way of looking at the equity markets hard-wired a lagged momentum strategy into his portfolio. It reflected his underlying belief that equity markets are noisy in the short-term but persistent in the long term.

I recall another famous portfolio manager who used a more quantitative approach to help separate signal from noise. He liked his stocks to show positive share price momentum over the first 11 of the past 12 months. He came to this view long before it became a popular strategy among quant investors.

This discipline meant that his portfolio was generally overweight stocks with decent fundamental momentum, but he ignored share price moves over the past month. His argument was that short-term prices were either position or news-driven. Neither were areas where he felt his longer-term approach would give him an edge. In his words: “I’ll leave that to the gamblers and insider-traders.”

This entrenched reluctance to chase market noise meant that, for both fund managers, portfolio turnover was low. Hence, they weren’t especially popular with my colleagues in trading.

Indeed, early in my career, I worked out that the trading floor wanted the opposite strategy. They loved to tout news stories or investment research justifying recent share price moves as the beginning of the next big thing. Every sales call began with “the market is changing its view on . . . ”.

The perfect quant idea generator for them would be one that picked stocks where the last month’s share price move represented a reversal of the previous 11 months. Maybe that’s because it was the best way to get attention from busy fund managers and a follow-on trade. Investors might want signals, but trading floors love noise.

Is this just a long-winded way of repeating Paul Samuelson’s famous quip “the stock market has predicted nine of the last five recessions”? Maybe, but I’ve shown how two highly respected market practitioners embedded this intuition into their investment processes. Of course, they used many other inputs, but their strong track records suggest that they were on to something. They certainly taught me lessons I will never forget. With investors currently chasing noisy Trump trades, it seems like a good time to pass those lessons on.