Signal-to-Noise Ratio
British science fiction writer Arthur C. Clarke said, "Two possibilities exist: either we are alone in the universe, or we are not. Both are equally terrifying." I am an optimist at heart and believe we are not alone. The universe is so vast that somewhere out there, the juxtaposition of stuff that creates life had to happen somewhere besides Planet Earth. It seems to be a reasonable bet; call it 6 to 5 for the aliens.
But so far, no good.
Most recently, I was bullish on "fast radio bursts." These are astrophysical space phenomena where weirdly bright flashes of light, registering in the radio band of the electromagnetic spectrum, unpredictably and repeatably blaze for a few milliseconds before vanishing without a trace. Scientists at first were confused because the array of possible natural sources would only produce a single, one-time burst. Unfortunately, aliens were ruled out as a potential source after more legit sources were confirmed (read about it here and here)
Oh well.
What was interesting to me is finding the signal in all of the noise. Giant telescopes continuously record activity in space, and scientists are looking for something of value that only lasts milliseconds. This galactic signal-to-noise ratio reminds me of the mind-numbingly small signal-to-noise ratio investors deal with every day regarding market information, economic data, and general news flow.
It seems now more than ever we are bombarded by noise given our ease of access to it: smartphones, social media, a multitude of network and cable news channels, etc. This "supply-side shock" of noise is unprecedented and makes finding the true and important signal ever more difficult unless you have a filter.
Our team's approach to the noise is regimented. We first filter everything through our latticework of investment mental models that inform our understanding of how the world works — and not through some bullshit "expert" or someone on social media or a pundit on TV. We think about whether something has merit, is new, interesting, and pertinent to our understanding of the world and investment objectives. We form our own opinions. We debate both internally and externally with a close group of respected colleagues. We keep strong opinions that are loosely held: our opinions are flexible and adaptable to new data. Our opinions are held purely and without interference from outsiders who do not align with our investment principles and our process. Pundits be damned.
Despite the tsunami of daily data and news flow, we believe only a handful of high-powered, important economic data indicators should be focused on, given our investment principles and process. We focus on those that help us figure out where we are in the business cycle. We disregard most of the rest. When those important signals change, we change our opinions. As noise comes in, we can easily and, importantly, quickly figure out if it is helpful or not.
Like the fast radio burst scientists, we will continue filtering the noise and finding the important signals!