In 1950, Geoffrey H. Moore, an economist at the National Bureau of Economic Research, buried himself in 60 years' worth of data on the American economy. Moore was looking for signals that would consistently predict when a boom or a bust was on the horizon, and he found them, emerging from his research with a short list of eight key statistics that he dubbed "leading indicators." Moore's innovation revolutionized the art of economic forecasting. It also had the inadvertent effect of spawning a host of imitators: Today, in a typical week, investors and executives will hear about durable-good orders, new building permits, consumer confidence, home resales, and the third revision of the previous quarter's GDP number. They'll also have to navigate a ceaseless flood of corporate earnings reports, nonstop commentary from the financial media, and the occasional off-the-cuff pronouncement from the White House. If the problem when Moore started his work was that there wasn't enough available economic information, then the problem today may be that there's too much.
Information is usually considered a good thing. But if the past year's market turmoil suggests anything, it's that certain kinds of news actually seem to make things worse. Not all information, it turns out, is created equal. And the way news is delivered can have a profound effect on the way it's received.
That's because there are two kinds of information in a market economy: public information and private information. Public information is the stuff that's accessible to everyone: economic statistics, survey data, stock prices, headlines. Private information is the stuff that only individual investors and businesspeople know, and it includes everything from the results of that new product test to the buzz a company is hearing from its suppliers and customers. In a healthy economy, there's a balance between the two kinds of information. Executives are making their decisions about the future with an eye on the public news. They're also paying close attention to what their private information is telling them.
The problem with public information is that it's the proverbial double-edged sword. On the one hand, it often conveys news that really is valuable to economic decision makers. On the other hand, public information often has an impact that is out of all proportion to its real value -- at times, it even overwhelms private information.
In part, that's because public information seems to be inherently authoritative: It's generally released by the government or well-respected organizations, such as the Conference Board. If a businessman's business seems to be turning up even though he's confronted with headlines about how the New Orders Index shows that the economy is in the doldrums, he may discount his own private information and pull back. But public information also has a powerful impact simply because everyone assumes that everyone else is paying attention to it.
The point is that public information can sometimes turn investors and businesspeople from individual decision makers into a herd of sheep. Look at the recent behavior of investors. In 1999, at the height of the stock-market bubble, all it took for a stock's price to skyrocket was a report on CNBC that some Wall Street analyst had set an outlandish price target on that stock. Investors bought the stock, not because they believed that the company's fundamentals were good, but because they were being told that everyone else was going to be buying it. Today, investors are behaving in the same way -- but in reverse. The public-information echo chamber magnifies the chatter and makes it harder for the economy to get out of whatever rut it's in.
The barrage of information and pseudo-information has been magnified by the explosion in financial news over the past decade. In the late 1980s, psychologist Paul B. Andreassen did a series of experiments with business students at MIT that showed that more news does not necessarily translate into better information. Andreassen divided students into two groups. Each group selected a portfolio of stocks and knew enough about each stock to come up with what seemed like a fair price for it. Then Andreassen allowed one group to see only the changes in the prices of its stocks. Students in that group could buy and sell if they wanted, but all they knew was whether the price of a stock had gone up or down. The second group was allowed to see the changes in price and was also given a constant stream of financial news that supposedly explained what was happening with each stock. Surprisingly, the less-informed group did far better than the group that was given all the news.
The reason, Andreassen suggested, was that news reports tend to overplay the importance of any particular piece of information. When a stock fell, its fall was typically portrayed as a sign that further trouble lay in wait, while a stock that was on the rise seemed to promise nothing but blue skies ahead. As a result, the students who had access to the news overreacted. Because they took each piece of information as excessively meaningful, they bought and sold far more frequently than the people who were just looking at the price.
In the end, of course, following the herd is not a recipe for success, since the only way to establish a competitive advantage is precisely to do what everyone else is not doing. That's why, in the long run, private information ultimately trumps public information. But in times marked by uncertainty and fear, like the year that we've just gone through, it's easy to succumb to the comfort of the crowd. The challenge for businesses and investors is to pay less attention to what everyone else is thinking and more attention to their own private information.
James Surowiecki (email@example.com) is a financial columnist for the New Yorker.