Monday, June 6, 2016

‘Bull-Bear’ Rollercoaster of Indian Stock Markets: Mitigating Behavioural Irrationality by Informational Rationality

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.


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.  


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.


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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