Why investors can't think for themselves?

Jun 21, 2010

In this issue:
» Deepak Parekh on India's infrastructure financing concerns
» Sensex P/E: High or low?
» Yuan de-pegging: Opportunities and problems
» Saving the world from a double-dip recession, the Roubini way
» ...and more!!

--------------------- A Good Time To Sell Bad Stocks ---------------------------------------
You never know when the stock markets will crash... but sooner or later, they will. No question about that. So the real money making question is - Are your prepared for this eventuality? Is your portfolio 'crash proof'?
Well, a good way to start is by getting rid of the 'bad stocks'. What are these 'bad stocks'? How do you identify them? For answers to these questions, and more, click here...

Today's Wall Street Journal carries an interesting article on how investors behave while investing. It questions why do investors so often seem to resemble a school of fish, all changing direction together. It also questions why investors can't think for themselves.

And the answer it puts forth is what behavioural economists call 'confirmation bias'. In other words, investors often go along with the crowd because they feel good when others also conform to their biases and thoughts.

As the report suggests, the value we place on something is likely to go up when others tell us, is worth more than we thought. It goes down when others say it is worth less! And stockmarket investing is no different. When markets go up sharply, you generally tend to believe that the rally is for real and stock prices will never fall again. And then, when the markets crash, you might feel as if everything is a sham and stocks will never rise in prices again!

The rally of 2007 and the crash of 2008 are two very recent examples of such behaviour we have in front of ourselves. First, everyone was buying. And then, everyone was selling!

So, how can you get over such a bias that clouds your thinking? Stay away from the crowd and think independently. Do your own homework and then act on it. Buy good stocks even when everyone around is selling, and sell bad stocks even when everyone around is advising you to buy!

 Chart of the day
Today's chart gives an insight into the valuation of the Indian markets (represented by Sensex) at different peak levels in the past. From a P/E of almost 57 times during the peak of 1992, the multiple stood at 34 times at the height of the dotcom bubble. And then in January 2008, when the markets peaked again, the Sensex's P/E multiple stood at 28 times. So, while the Sensex had made new highs in the past, its P/E level has come down...perhaps an indication of India's enhanced reputation in the global markets as also a lower interest rate regime!

Data Source: CMIE Prowess, Hindu

"We need more longer-term money for infrastructure and we need new sources of funds for infrastructure to meet out infrastructure requirements." These are the words of Mr. Deepak Parekh, HDFC's Chairman and a leading hand in India's infrastructure policymaking. Mr. Parekh is worried about how India is going to meet her infrastructure financing needs. He is especially concerned as long term funds (that are a must for infrastructure financing) are not coming to India.

As he rues, "I, as a banker, am terribly disappointed that people are borrowing short-term money to meet infrastructure gains. No one wants to pay high rates of interest. They all want to raise one-year money to do a ten-year project. They want to raise one-year money and roll over year after year because the one-year rate is cheaper than the five-year rate."

The infighting between the mutual fund and insurance regulator got its fair share of media attention in recent times. So much so that the product in contention - ULIPs (unit linked insurance plans) - almost had no takers! There was confusion about the regulation as well as the utility of the product. With SEBI having banned it, the IRDA left no room to ensure its authority over these popular schemes. It has given insurance companies additional time to redesign the product.

The aim is to make it a lower risk - fixed return one. Needless to say that it will be bundled with insurance policies! Thus IRDA believes that the combination of insurance, low risk and fixed return will make the product alluring. Whether or not that is the case is yet to be seen. However, what is more important is that the product is no more mis-sold with false promises.

The stock markets have been jittery for the past few months. Sharp rallies are followed by sharp declines and investors are back to square one. No such worries for the yellow metal. The price of gold has hit a record of nearly US$ 1,260 an ounce due to its status as a haven from sovereign and financial risk. The price of the commodity has risen by nearly 15% since the end of 2009, fuelled by sovereign risk in the euro zone, low interest rates and concern about the stability of paper currencies. In fact, many experts are also bullish on the precious commodity. Marc Faber recently said, "I buy gold, I don't know what else to buy."

The US consumer, one of the main drivers of global economy will not return to his old days in a hurry. He has hunkered down and will perhaps spend the next few years repaying his debt. Thus, there hung a big question mark until recently over who would now drive the global economy. The answer, to some extent, was provided by the Chinese authorities last Saturday.

China announced that it would effectively de-peg its currency. This thus sets the tone for a fresh appreciation of the Chinese Yuan. It also provides a booster dose the global economy was so badly looking for. A rising Yuan puts more purchasing power in the hands of Chinese consumers and its firms. And this in turn leads to increased demand of goods and services for nations exporting to China. Besides, the appreciation is also positive for other Asian nations competing with China for a share of the exports pie.

The move could present another headache for the Indian central bank (RBI) though. Capital flows into emerging markets could surge yet again, raising fresh concerns about asset bubbles. Clearly, the Chinese de-pegging has the potential to give rise to completely new set of problems and opportunities. We hope Indian authorities are equal to the task.

Anyways, the Chinese Yuan de-pegging news had a positive impact on Indian markets today. The BSE-Sensex was trading with gains of around 320 points (1.8%) at the time of writing this. These gains were largely led by stocks from the metals and realty sectors.

Other key Asian markets also saw strong buying today. The gainers' pack was led by China (up 2.9%), Hong Kong (up 3.1%), and Japan (up 2.4%). Stocks across Europe have also opened on a positive note.

So, how do governments across the world ensure that their economies are not subject to a double dip recession? If they withdraw their stimulus measures now, economies will further stagnate. Especially because demand has not yet picked up and business conditions have not improved. But if these measures go on for too long, then it raises the risk of asset bubbles, inflation and runaway fiscal deficits.

Thus, noted economist Nouriel Roubini opines that the US and other debt laden countries need to spend less than the income they generate. They have to do away with the tag of being consumers of the first and the last resort. But this has to be balanced by the emerging economies, Japan and Germany. They have been the producers of the first and the last resort. And now they need to save less and spend more.

Overall, Roubini lists various measures that governments need to follow to come out of this slump. The crux really is that developed economies will have to stick to their easy monetary policy. Especially the ones who are still mired in recession. Further countries such as China and others having current account surpluses will have to reduce savings and let their currencies appreciate. In general an overall rebalancing of the global economy is in order. The question is whether it will actually be put to practice.

 Today's investing mantra
"Man's imperfect, limited-capacity brain easily drifts into working with what's easily available to it. And the brain can't use what it can't remember or when it's blocked from recognizing because it is heavily influenced by one or more psychological tendencies bearing strongly on it." - Charlie Munger

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4 Responses to "Why investors can't think for themselves?"

A Nathroy

Jun 22, 2010

It was an excellent reading. You deserve compliments for bringing such simple insights to our notice. Keep it up !



Jun 21, 2010

You are doing a good job. Keep it up. Add more information on the dollar if possible.



Jun 21, 2010

your daily mail will explore not only to understand the past and also the gennune of the future.


Chandrashekhar Vaidya

Jun 21, 2010

The barchart showing P/E multiples at different times is quite illustrative. Inverse of P/E multiple will reveal the returns that accrue to an investor. Amongst other things, this return will be affected by safe returns such as from government securities. Is it possible to compare the safe returns vs stockmarket investor's returns? Will this lead to understand a meltdown?

Equitymaster requests your view! Post a comment on "Why investors can't think for themselves?". Click here!