Stock markets
are considered to be the ultimate barometer of investor confidence in a
nation’s economy. A healthy and vibrant stock market helps small investors of a
nation make gains that can beat inflation in the long term. Indian stock
markets have opened up to foreign investments after liberalization, and over
time this has resulted in the Indian stock markets getting coupled to global
markets. Foreign institutional investors (FIIs) determine to a large extent the
ups and downs of the Indian stock markets based on their inflows and outflows.
FIIs have a global canvas to invest and their relative allocations amongst
countries and relative shifts have a profound effect on national stock markets.
What happens in the Indian stock markets is thus a combination of domestic
factors and global factors.
Indian stock
market regulations have, over the years, been progressively reinforced and refined
with greater operational disclosures and better governance standards.
Opportunities have been enhanced for public participation with prescription of minimum
public float, both for public and private sector companies. Norms and
procedures for initial public offers (IPOs) and follow on public offers (FPOs)
have been streamlined with measures to avoid locking up of small investors’
capital. Easy listing norms for startups are also on the anvil. Despite all
these measures, the Indian stock markets continue to be infamous for the rollercoaster
rides and unexpected bull and bear cycles. Some experts opine that Indian stock
markets are predominantly news and operator driven, and do not always carry a
healthy correlation with either the state of the economy or the level of
performance of companies.
Bull-bear
Stock market
analysts tend to simplify market movements to bull or bear cycles which take
place under the sunshine or storm, respectively, of global macroeconomic
developments. Stock market analysis is one domain where analysts’ moral commitment
to what they say is notoriously weak, and correspondingly where public memory
is notoriously short. Around an year
ago, analysts spoke of Sensex (Indian stock market benchmark index) crossing
the 30000 mark effortlessly by end-2015 and even doubling itself in three
years. In January-February 2016, however, all of them began talking of an
imminent crash to around 15000 mark. Again, this June there is talk of a
secular multi-year bull run. From time to time, there tends to be much emphasis
on an invisible collective bull power or bear hug of the markets rather than on
the performance of industrial sectors or companies; inevitably there is no
accountability on missed forecasts.
Events in
economy become outcomes in markets for operators. The markets witness exuberance
whenever favourable announcements are made on economy, fiscal policy, monetary
policy, foreign investments, monsoons, and so on. On the other hand, any
perceived adverse news in such matters leads to gloom. In doing so, markets price in expectations
that cover one year plus outcomes in just that day’s or that period’s price.
This is an interesting feature of behavioural finance that makes people respond
to momentary data in a compulsive manner. When a whole universe of investors
goes berserk in that manner, sudden bull and bear formations take place with
current price-earnings (PE) guideposts thrown out based on future PE ratios and
people wanting to have (or get out of) their share of the market at any cost.
There is no mechanism yet of how the bull and bear impact can be circumvented,
except the Buffet way.
Behaviour
Warren Buffet
is considered to be the most successful investor in this world. Buffet says he
is never influenced by generic trend of the markets being in either bull or
bear grip. He does not look for short term sharp returns. Instead he buys into
companies and managements based on detailed internal information which is available
to him as a large investor in a perfectly legitimate way. Not all will have a
large portfolio nor the deep information to do a Buffet act on a retail basis.
Most will also not have any time to analyse or grasp the key issues. Given
these limitations, what one can do is to understand the nuances of behavioural
finance and mould one’s approach towards the markets accordingly, understanding
one’s life goals and one’s intrinsic limitations.
Professor
Daniel Kahneman who won Nobel Prize in economics in 2002 for shattering the
assumption that economics is rational has a lot to say on economic behaviour of
individuals. His life’s work is anchored in studies showing that people are
irrational. His works argue that people are prone to “cognitive biases” and
“systematic errors in thinking”, made worse by chronic over-confidence in their
own judgement – and the less intelligent they are, the more militantly certain
they tend to be. Very relevant to stock market investing are his propositions
that people do not always act in their own economic self-interest. Nor do they
strive to maximize “utility” and minimize risk, contrary to the assumptions of
efficient market theory and the core premises of the economics. He holds that
people are myopic and human brain circuits respond to immediate consequences.
Chance
Depressing may
it seem, Professor Daniel Kahneman concludes that individual investors are so
persistently incompetent and incorrigible that they fail to recognize their own
economic misbehaviour; they amplify their profits, fail to crystallize their
losses and avoid own up their failures,
leading to a costly asymmetry. Having made these very insightful and
pertinent observations, he offers no solutions either. He holds the funds,
mutual or hedge, which are managed by fund managers also to be susceptible to
the behavioural follies; he concludes laconically that the only thing certain
with funds is their fees, besides entry and exit loads. Universe and stochastic
processes are a great leveller; for those investors who make handsome economic profits
in such asymmetrical investment scenario, there would be an equal number making
precipitous losses. This see-saw of profits and losses reduces stock market
investing by individuals to a game of chance where fortuitous timing and dogged
patience pays, but only to an extent and never in an absolute sense.
A review of
Sensex trends over the past few decades and company stock price movements over
time suggests that the only thing that matters is when someone enters the
market and when he would exit. Apart from the availability of investible
surplus or the urgency of monetary need, the timing tends to be one of chance.
The reason is that markets are irrationally rational. They are rational to the
extent of appreciating a cause and effect approach but they are irrational in
terms of the nature and quantum of response. In addition, there is a huge
asymmetry in information, with no single agency being responsible for holistic
analysis of all the trends that could impact the performance of companies and
markets. When individual behaviour is based on logical asymmetry and is unknowingly
irrational and complacent, the only way to minimize the impact is through
greater information access.
De-stock, exchange!
Regulators in
India have done great things in recent years to enhance timely, pre-formatted
disclosures through stock exchange sites. Over the last few decades, exclusive daily
business and economic newspapers and 24X7 specialized television channels to
present daily economic and business information and track stock market
happenings have become very pervasive and popular. In addition, firms have tied
up with stock exchanges to capture real time market data and presented
corporate data to develop multi-layered databases for investors. All this have provided more information at the
hands of investors than they had ever. The issue, however, is with
classification of open source raw information, pricing of analytical
information and access to both types of information. If regulators are committed
to healthy growth of stock markets and protection of investor interests, as
indeed they are, the stock exchanges must establish a non-profit or a
subsidised organization to provide raw and analysed information to all sections
of population on a free of charge basis.
Stock exchanges
are the platforms with daily turnovers in the range of Rs 20000 crore
approximately while a few hundred crores are collected annually through
transaction taxes. Stock exchanges should utilize a fraction of the funds
generated to provide to the investors the following: (i) a daily information
newsletter including all submissions of the day, (ii) a daily newspaper
providing corporate performance data, (iii) a television channel which provides
stock market and company performance data (without advertisements, interviews
and induced biases), (iv) a mega portal which provides company and stock
performance data in raw form, classified into large, medium, small and micro
sectors in each industry as well as across industries, and (v) an analytics infrastructure
which analyses the raw data in terms of multiple analytical formats and trends.
If stock exchanges feel that any compilation and analysis of data through media
impacts their independent status they can promote an independent corporation to
undertake such activities. De-stocking of the huge amount of information that
passes through the exchanges each day and presenting it meaningfully and
analytically is essential for investors to moderate the travesties caused by irrational
and vulnerable human financial behaviour.
Posted by Dr CB
Rao on June 6, 2016
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