Are you suffering from confirmation bias?

Jan 10, 2011

In this issue:
» India's high growth helping global recovery, says World Bank chief
» This could hurt India Inc's profits in 3QFY11
» Indian companies eyeing Africa's treasures
» India requires more FDI, not FII money
» ...and more!!

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"Quantitative easing is working. Inflation is a percentage point higher and there will be 3 m more jobs in 2012 because of the US Federal Reserve's programme of asset purchases." These are the words of the US central bank's vice chairperson. Call it a typical case of confirmation bias.

Wikipedia defines a confirmation bias as a tendency for people to favour information that confirms their preconceptions or hypotheses regardless of whether the information is true. So if the Fed believes that quantitative easing (QE) will work, it will be consistent in its views even when it doesn't work.

This is typical of so many investors. After having bought a stock, and then realizing that the company isn't as good as was originally thought, an investor would continue to hold on to it even if it is going down. Instead, he would try to give explanations of why he is right in holding the stock. And instead of realizing his mistake, he will continue to confirm to his original decision.

History is proof that nothing has caused a bigger loss to an investor than his confirmation with his original but incorrect investment ideas. As far as the US Fed is concerned, it is falling in the same trap. More money can't solve the crisis that was caused by excessive money. The Fed doesn't seem to understand this.

 Chart of the day
Today's chart shows the movement of raw material costs (as percentage of sales) for Indian companies over the past few quarters. After hitting the peak of nearly 58% of sales in the quarter ended September 2008, these fell to a bottom of 43% of sales in March 2009. These have risen since then, though are still lower than their 2008 peak.

Note: Data is representative of BSE-200 companies; Source: CMIE Prowess

India Inc. is all set to start announcing its December quarter results. Most companies have seen good order inflows in recent times, so that would boost their revenues. However, we believe that the performance could be dampened to some extent. Surging commodity prices and inflation would be the biggest party poopers. Just as higher prices eat away the incomes of individuals, similarly they are likely to eat the margins of the companies. Inflation has been touching new highs despite the government's attempts of controlling it. In addition to this, prices of most commodities have surged to higher levels. So while the revenue growth might touch new heights, margins are likely to remain under pressure.

As if last week's hammering wasn't enough, Indian markets had to face volatility again today. The BSE-Sensex was trading with losses of around 325 points (1.7%) at the time of writing this. Today's losses were led by stocks from the engineering and power sectors. Most other key Asian markets also closed weak today. While China was down 1.1%, Singapore was weaker by 0.5%.

The list of high profile visits to India has a new member on it. This time though, it is not the head of a state. Instead, it is the head of perhaps the biggest financing institution in the world, the World Bank. Yes, that's correct. Mr. Robert Zoellick, the bank's President will be in India soon for a four-day visit.

"India's return to high levels of growth is helping the global economy recover from the crisis," Mr. Zoellick is believed to have said ahead of his visit. Oh yes, India's current account deficit and its capital inflows which is making FIIs richer is no doubt helping the global economy recover. But sadly, it is not helping its own citizens to the extent required. The reason - persistently high inflation. And this inflation, besides being of supply side in nature, is also being caused on account of various infrastructural bottlenecks. Of course, Mr. Zoellick would do his bit in ensuring that money from World Bank is available for various projects. We wonder if he can do something to stem the rampant leakage of funds that ensues whenever a big public project is undertaken. More than the funds, this could be of even greater help to India we believe.

We are living in interesting times. We have witnessed new beginnings and beginnings of the end of economic super-cycles across the globe. While Europe and the US head toward doom, Asia has been the emerging centre of economic power. But that is not all. There is another continent which bears the scope and promise of tremendous growth. We're talking about Africa. After centuries of natural and man-made disasters, signs of a long incumbent desire for economic well-being are evident in the continent.

The IMF said in October that sub-Saharan Africa is expected to register a growth rate of 5.5% in 2011. This will be second only to Asia. India doesn't want to miss this great chance. Already, millions of mobile phone subscribers in Africa saw the icon on their phone screens change to Indian company Airtel last fall. The expansion by Bharti Airtel into 16 African countries underscores the rise of India in Africa. The Indian government is raising its diplomatic profile in Africa. The historical ties and our democratic politics also stand to our advantage. However, China has huge investments in Africa already. And Indian companies will have to strive hard to keep up with the dragon economy's business profile in the continent.

India's economic position today is envied by many. We are not just referring to the developed economies facing the threats of miniscule growth and sovereign bailouts. But also to those like China where the population is ageing much faster and growth is dependent on external consumption. The domestic consumers there have been deprived of consumables to facilitate exports. Unlike them, Indians at large have been able to benefit from free trade. With no cap on currency movements, imports have become cheaper. Also Indian companies are forced to become more competitive. We are not surprised if you think that this reads like a one-sided argument.

As per the Wall street Journal, most global economists have a contrarian view on this. They believe that India's attempt to fund imports through capital flows is good only to the extent that the latter is sustainable. They share the fear that most capital inflows so far have been short term in nature. This is because the long term investment in the form of FDI has met with several regulatory hurdles in most sectors. Also, delays in land acquisition and allocation of resources have dogged several projects. In view of these, India's ballooning current account deficit is running the risk of becoming unmanageable. Especially if the short term FII inflows were to completely dry up. Given the current state of developed economies, we do not see this happening anytime soon. However, the replacement of FII with FDI money will certainly make the India story more sustainable.

 Today's investing mantra
"Successful stocks don't tell you when to sell. When you feel like bragging, it's probably time to sell." - John Neff

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1 Responses to "Are you suffering from confirmation bias?"


Jan 11, 2011

i am just looking for it subscribes charges. i live in &work in Hong Kong but i want to join from india .

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