“Headline risk” is a well-known phenomenon in trading and investing. Investopedia defines it as “the possibility that a news story will adversely affect a stock's price” or, as they point out, the stock market as a whole.
I would add another danger: That headlines can prompt people into making trades that make little sense when subjected to calm, rational analysis. There are two examples of that right now, one relating to the broader market, and one stock-specific case.
From the wider perspective, the market has been volatile recently as traders react to every headline regarding trade. Over the last couple of weeks there have been some big intraday moves in the major stock indices as news has broken about the breakdown of trade talks with China and the escalation of tariffs that resulted.
In some ways that is perfectly logical. Apart from disrupting trade, tariffs have the effect of slowing economic activity. The cost is not really borne by the target country, but by consumers in the importing nation. They are, in terms of their economic effect, a tax on consumption, and that threatens growth.
The fact is that tariffs have been in place for a while now and while they may have had a dampening effect, both the U.S. and Chinese economies have continued to grow. That suggests that the White House’s assumption that current economic strength allows for some disruption in search of a better long-term trade deal is a fair one.
If you believe that to be true then, for long-term investors, reacting to every headline, or worse still, every Presidential tweet, makes no sense whatsoever.
If we have learned nothing else over the last two years, we have definitely learned that consistency is not President Trump’s strong point, so chasing every headline will just leave you dizzy and confused. Your portfolio decisions should be based on more fundamental, long-term trends and as long as interest rates stay low, stocks look like a decent investment.
When it comes to individual stocks, some are more prone to headline risk than others, and one of the most headline-sensitive out there is Tesla (TSLA). Elon Musk’s tendency to be controversial and make his hopes and dreams public have contributed significantly to that stock’s volatility over the last few years, but the current issue is not Musk’s fault. It is about something more fundamental to the danger of headline risk.
We live in a news-saturated world. The 24/7 news cycle and the appearance of news alerts on our phones means that we are bombarded with things to react to. The problem is that we tend to assume that because we see a lot of headlines about something, it is a common occurrence. Logic, however proves that to be the exact opposite of the truth.
What makes something newsworthy is its rarity, not its ubiquity. As the old saying goes, “Dog Bites Man” is not a headline, but “Man Bites Dog” is.
That is why investors should not react to yesterday’s headlines regarding a fatal crash involving a Tesla on autopilot. Much is being made of the fact that it is the third such crash, but that pales in comparison to the number of road traffic deaths from cars not on autopilot. In 2017, in the U.S. alone, there were over 37,000 such fatalities. If each of those were to generate a headline we would see over 100 of them every day.
So, when looked at logically and realistically, traders and investors should do their best to ignore the vast majority of headlines. They are designed to grab our attention and the easiest way to do that is to provoke fear. In the short term, fear and perception matter, but over time, logic and facts matter more.