Hashtag stock markets

In August last year, Donald Trump took to Twitter. It was a Friday and the US president decided to use the social media platform to talk about China.

Within minutes of ‘ordering’ US companies to find alternatives to their Chinese operations, the Dow Jones Industrial Average had sunk by 2.4 per cent and the S&P500 by 2.6 per cent. By the following Monday, both indices had recovered - but only a fraction of the lost ground.

Investors have long had to keep a watchful eye on macroeconomic indicators, traditional media and the interplay between markets and politics. Now they have another front to contend with: the social networks.

Uncertainty

"Twenty years ago, traders prepared for their day knowing that an event like an economic release was coming at a certain time," says Joshua Mahoney, senior market analyst at trading and spread-betting platform IG. "Social media has turned that on its head, adding much more uncertainty."

JP Morgan Chase & Co has come up with a Volfefe Index - a cross between ‘volatility’ and the nonsensical word ‘covfefe’ that Trump once tweeted – in an attempt to measure the resulting effects on asset prices of the president's social media messages.

It found that Trump tweets using the words ‘China’, ‘billion’, ‘products’, ‘democrats’ and ‘great’ were affecting two-year and five-year Treasury bonds in addition to the volatility in their interest rates.

In a study last year, Bank of America Merrill Lynch found not only that Trump's tweets had a direct effect on markets but there was also a clear pattern: the market suffered on days when the US president tweeted more than 35 times. By contrast, it saw positive returns on days when he tweeted fewer than five times.

Volatility

“Trade talk, political campaigning and tweets have contributed to volatility, from China to Fed policy to tax policy,” wrote Savita Subramanian, Bank of America's chief equity strategist and author of the report.

But it is not just Trump. In May, Elon Musk, chief executive officer of Californian car manufacturer Telsa tweeted: "Tesla stock price is too high." The company's shares subsequently fell by 9 per cent, erasing US$13bn from its market capitalisation.

In the world of social media, Trump and Musk may be outliers for their power to influence. But other studies have found that content from the wider social media universe affects stock markets differently from traditional media such as newspapers and television.

As long ago as 2016, researchers at the University of Oxford found that high volumes of social media about individual stocks were followed by high volatility in returns and high trading volumes in those assets during the following month. However, intense traditional news coverage of the same dataset of individual stocks was followed by low volatility and low trading volumes during the following month.

"These effects are statistically and economically significant," the study concluded. "The difference between the impact of social and news media is striking."

So how should investors approach the influence of social media on stock markets and other assets? And is there a way to incorporate its effects into a portfolio strategy?

The good and bad of social media

Peter Dixon, senior economist at Commerzbank, says that one thing they cannot do is turn a blind eye. "You have to keep close tabs on the things you are interested in, and that includes using social media," he says. "If you are exposed to political risk in Africa, for example, social media can alert you to potential concerns before mainstream media does."

Yet it can also create false data that could lead investors astray, for example, by generating ‘noise’ around a particular stock as part of so-called ‘pump-and-dump’ schemes, which aim to ramp up share prices and then sell quickly.

Stock markets the world over are stepping up surveillance of potential market-manipulation schemes, and social media is one of the potential sources of that manipulation they are examining. Today's prevalence of high-frequency trading systems, which are built to carry out trades based on keywords scanned from multiple online sources, only serve to magnify the concern.

At the same time, an entire industry has grown up around providing investors with sophisticated digital tools that can scour huge volumes of social-media content in the search for meaningful ‘emotional data’ that could predict the next investment opportunity.

"Hedge funds are seeking trading signals or trading models that will allow them to extend their existing portfolios," Stefan Nann, co-founder of data-analytics firm StockPulse, explained last year in an article on Nasdaq's website. "Private equity companies want to find new investment opportunities based on alternative data that are not yet accessible to everyone."

For many investors, such sophisticated approaches to analysing social media content for potential gain are beyond reach, which often means that they are left to deal with the resulting volatility that tweets and other online content produces.

Mahoney argues that their response should be to maintain a diversified portfolio that can spread the risk and help ride out any short-term volatility. "You have to look for long-term value," he says. "Never expect anything to stay the same."