There are four fallacies that show up in the financial media over and over again. You can find them on a constant basis, in countless articles, stories, and reports. Pundits on cable financial channels spout them off daily — and investors can fall prey to them in their own thinking.
These fallacies are common because there is an underlying logic to each one. The problem is the way the logic gets twisted by poor analysis or emotional bias.
If you make a habit of watching out for these fallacies, you can learn to spot them like Easter eggs. As a bonus, this could help make you a smarter and safer investor.
To preview, these are the four most common financial media fallacies:
- The non-sequitur (conclusion does not follow from premise)
- The post hoc fallacy (assuming event A caused outcome B)
- The reduction fallacy (assuming complex events have a single cause)
- The narrative fallacy (using stories to support an opinion or bias)
“Non-sequitur” is a classical Latin phrase that translates as “it does not follow.”
In popular terms, the non-sequitur is as an absurd statement. Non-sequiturs are beloved by certain comedians because a bizarre or confusing twist can be funny.
Here are two examples from the king of non-sequiturs, comedian Steven Wright:
- “I went to a place to eat. It said, ‘Breakfast at any time.’ So, I ordered French toast during the Renaissance.”
- “I’ve been getting into astronomy, so I installed a skylight. The people above me are furious.”
In financial media, a non-sequitur is an argument where the premise and conclusion appear related at first glance but have no relation upon closer look.
Here are three non-sequiturs that recently made the rounds:
- The yield curve inverted, so investors should sell their stocks.
- Lyft shares are a buy because the U.S. transportation market is worth $1.2 trillion.
- The U.S. national debt is at a record $22 trillion, so markets are going to crash.
Each of those statements appears to have a logical connection at first glance. But when you look closer, the connection isn’t there. The conclusion actually has nothing to do with the premise:
- An inverted yield curve is a legitimate recession warning with a 50-year track record. But it doesn’t tell you when to sell stocks, and equity markets have historically done well in the 12 to 18 months after an inversion (as we explained here).
- Lyft is going after a big market (the U.S. transportation market), but so is Uber, a brutal competitor, and so is the self-driving car industry. Big target markets and big rivals can mean big cash burn, something to avoid as explained here. As of this writing, and less than three weeks since the IPO debut, Lyft (LYFT) is down 35% from its opening day high.
- It’s true the U.S. national debt is at a record high, and that big problems could be coming down the road. But that doesn’t mean markets will crash. And in fact, debt levels don’t directly connect with crashes at all. There are scenarios where markets go sideways versus down, or where central bank support makes nominal stock prices rise (as inflation eats away real returns).
The gist is, you will often find non-sequitur arguments in the form of “because of premise A, conclusion B follows,” and then the connection will be nonexistent or false. It’s like looking for license plate combinations on a highway road trip — if you keep your eyes open, you’ll spot them all over the place.
The post hoc fallacy is short for “post hoc ergo propter hoc,” which is Latin for “after this, therefore because of this.”
This fallacy assumes that, because X happened and then Y happened in sequence, X caused Y. The financial media indulges in the post hoc fallacy every single day, like clockwork and without fail. This is the way journalists explain short-term price movements.
Here is a recent example, in a headline taken from Barron’s:
“A 1.4% Drop for Bitcoin Because China Wants to Ban Mining, and Two Other Numbers to Know”
Here is what happened to generate that headline:
- A Chinese government agency strongly hinted at a crypto mining ban
- The Bitcoin price fluctuated and wound up down 1.4%
- A financial journalist at Barron’s needed to write something
The price of Bitcoin can move around so much — in the week of April 1st it jumped more than 20% — a 1.4% fluctuation is statistically meaningless. Moves of less than 2% happen routinely, often for reasons involving no news at all.
But a journalist saw the China news, and reasoned Bitcoin is the king of cryptos, and assigned a connection to the price fluctuation that day.
Again, this happens all the time. Almost every time you read a headline “Investors did X because of event Y,” both sides of the equation are either a seat-of-the-pants assumption or a wild guess.
Journalists don’t actually know what investors are doing — Which investors? Individual investors? Hedge funds? Pension funds? — and unless the connection to a piece of market news is very clear and documented, the “because X, then Y” assumption may not actually hold at all.
But headlines and market recap articles must be written daily, and consumers of financial news would rather get a smart-sounding explanation than read “prices randomly fluctuated for the zillionth time” — so the post hoc fallacy dominates.
The reduction fallacy, meanwhile, comes from a desire to simplify things that aren’t so simple. It stems from the subconscious belief that complex events have a single cause.
This belief (that complex events have a single cause) is also a desire, because if something has a single cause it is easy to interpret and understand; whereas, if something has many different causes, it is complex and harder to interpret or understand.
The global financial crisis of 2008 is a classic example of an event with no single cause. There were multiple factors that came together to create the global financial crisis.
You needed all of those factors working together, along with some very bad luck, in order to get the catastrophic result that occurred.
The reduction fallacy is also a problem for government regulators. Serious accidents or industry failings are often assumed to have a single cause, when in reality it’s multiple things in concert.
Take wildfires for example. If a downed power line causes a devastating wildfire in a residential area, you could say the single cause was the power line. But if you stop there, you would leave out a number of important factors.
The fire may also have been related to months of drought, a build-up of homes in a historically dry wooded area, a lack of firefighter equipment and crew support that could have contained the fire more quickly, a lack of water due to a depleted reservoir from over-use, and so on.
The danger of the reduction fallacy is that it creates the illusion of an event being simple — caused by that “one thing” — when the reality is not simple at all.
The reduction fallacy can be misleading or distorting if it leaves out crucial elements. When applied to important areas — investment decisions relating to buying or selling a stock, or making an important life decision — the reduction fallacy can be dangerous.
And once again, you can spot the reduction fallacy in the financial media on a constant basis, because single-cause explanations — perfect for a two-minute soundbite — are always in popular demand.
Last but not least, the narrative fallacy makes use of stories to support an opinion or a bias.
Andrew Lang, a 19th century Scotsman, described how politicians “use statistics in the same way that a drunk uses lamp-posts — for support rather than illumination.”
That is also how the narrative fallacy works:
- You start with a point of view or a bias.
- You cherry pick a story or narrative to package it.
- You use the narrative to convince others.
The cable financial channels have made an actual business out of this. They will say to their talking head guests, “Can you do a segment where you are bullish on ABC?” or “Can you take the bearish point of view on XYZ?” Then the pundit tells a story in line with the view they were asked to support.
The narrative fallacy is dangerous because it’s a way to convince other people, or yourself, of believing something without gathering evidence.
Stories used to support an opinion are a kind of rhetoric disguised as evidence. This can feel like doing research, but it isn’t. It’s more like preparing for a debate.
That is very different than trying to be objective, striving to maintain an unbiased point of view, and then drawing a conclusion based on what the evidence says, which is what successful investors do.
How do you protect yourself against these common media fallacies?
The most direct way is to recognize how common they are, and then try to spot them as a habit. You can even make it into a game. When you hear or read something that sounds logical on the surface, put on your skeptic’s hat and dig below the surface. You may be surprised how often a fallacy turns up.
If you get into this fallacy-spotting habit, you may also be surprised at how big and blatant some of these fallacies are. They can actually be laugh-out-loud funny at times.
Another thing you can do is build up your analysis capabilities with investment tools that are fallacy-free, based on information and data rather than opinion. As the Silicon Valley legend Jim Clark used to say, “In God we trust. All others must bring data.”
One of the advantages of TradeStops is the ability to deliver information on individual stocks, your portfolio itself, and the state of the market as a whole in straightforward, unbiased ways.
Algorithms don’t get fooled by fallacies or swayed by biased opinions. Having software as part of your investor toolkit can shield you from financial media fallacies.
Richard Smith, Ph.D.
CEO & Founder, TradeSmith