Do investors fail because of 'lizard brains'?

Jul 12, 2013

In this issue:
» Funding the CAD gap a big worry for India
» Stock markets give thumbs up to Infy June quarter result
» Why has the global recovery failed?
» Why a good monsoon should make you worry?
» ...and more!

Just a few weeks ago, the global markets had pressed the panic button after US central banker Ben Bernanke hinted about a likely pullback of its quantitative easing program. In less than a month's time, he seems to have changed his stance. In his latest speech, he assured that the central bank would continue to pump cheap liquidity. The reason for this is that the US Fed is far away from achieving the mandated employment and inflation targets. But this news sent global markets soaring. What an irony that bad economic news tends to boost stock markets! On several occasions, we have highlighted how this liquidity-driven global stock market rally is unsustainable. But the markets seem to have lost touch with reality.

A question that comes to mind is- Why are financial markets behaving so irrationally? We came across a very interesting article in PBS Newshour that gives a biological explanation to the madness of the markets. The article highlights the views of a gentleman called Terry Burnham who is the author of books such as "Mean Genes" and "Mean Markets and Lizard Brains".

Mr Burnham believes that the US stock markets are going to witness a "devastating decline". What's his reasoning behind this view? He believes that there are very clear signs of an impending collapse. But then why are investors not able to see it? As per him, the problem is with the way our brains our wired. In two words, the answer is 'lizard brains'.

Let us explain what he means by 'lizard brains'. The term is casually used to refer to the most primitive part of the human brain. The lizard brain evolved in a way that suited its survival needs in a certain environment. But many of its responses are irrelevant in our modern social structures. And in the context of stock markets, lizard brain responses can actually be very dangerous.

As Mr Burnham points out, your lizard brain is programmed to find and act on patterns. So if a certain thing seems to have worked earlier, the lizard brain tries to replicate the same again. Let us extend this theory to stock investing. Say there is a stock that you really like. And you see it soaring up continuously. Other investors are optimistic about the stock. They seem to be making a lot of money on it.

What does your primitive brain do? It identifies a pattern that seems to be working successfully. And the next thing you want to do is go and buy the stock. No matter what the price is! The lizard brain propels this self-fulfilling prophecy. Until of course, you hit the wall. We believe this very well explains the reason why most investors fail.

Do you think your 'lizard brain' impacts your investing decisions? Please share your comments or post them on our Facebook page / Google+ page

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 Chart of the day
In financial year 2012-2013 (FY13), India reported its highest-ever current account deficit (CAD) of Rs 88.2 bn. As the chart of the day shows, since FY08 the deficit has been bulging at a rapid pace year-after-year. The CAD is likely to be lower in the current financial year (FY14). However, funding the gap is going to be a major concern this fiscal. As per an article in DNA, some experts have estimated the funding gap to be about US$ 25 bn (approximately Rs 1.5 trillion). Given the current global and domestic factors, attracting such a huge quantum of portfolio flows will be tough. In addition, the quantum of debt in the external funding mix has also gone up significantly.

Since May 2013, FIIs pulled out about US$ 8.15 bn in Indian debt. So it is quite clear that attracting 'hot money' is not a solution to India's CAD problems. Therefore, it is imperative for Indian policymakers to initiate long term measures to remedy our deficit problems and to save the Indian rupee from plunging further down.

Data source: DNA

The quarterly results season kick started with the much anticipated result announcement by IT major Infosys Ltd. The company has reported a 7.8% quarter-on-quarter (QoQ) growth in net revenues but a 0.8% QoQ decline in net profits. In US dollar terms, the revenues grew by 2.7% QoQ while the decline in profits was much sharper at 5.9% QoQ. The company maintains a cautiously optimistic outlook for the rest of the year. The stock markets appear to be cheering these results as the stock of the company has raced ahead in its trade today. But we wonder as to what is the cause for celebrations in the market.

One reason is that the decline is not as bad as what the street expected. Another reason could be the company reiterating its guidance for the entire year. In any case, such exuberance is nothing but a short term affair. The IT industry is facing headwinds which are likely to continue in the short to medium term. In addition to this, there is a chance that the margins for the company would come under pressure due to the wage hikes. But all of these issues are short to medium term in nature. As long as the long term outlook for the sector as a whole and for the company in particular remains strong, there is little to worry about. Long term investors would do well to not read too much into short term spikes and falls based on quarterly results.

It's been nearly five years since the financial meltdown happened. And yet, the global economic recovery is hardly worthy of the name, argues an article in Bloomberg. It further goes on to add that growth everywhere could and should be faster. So, what exactly has slowed things down? Well, the author believes that had co-ordination between international institutions and also amongst local agencies been better, we would have been much better off. Really? Is this just a problem of lack of co-ordination? That's not quite the case we believe. In fact, we think our problem starts right with the medicine that is being administered. Everywhere you see, authorities have thrown more money at a problem which itself was of excessive leverage to begin with. Therefore, the idea would have been to rid the system of excessive leverage and not burden it with still further debt. This way, there will be even bigger problems down the road.

Lastly, the authorities should not forget that just as Christianity is not possible without hell, there can't be capitalism without bankruptcy. Weak and inefficient firms, no matter how big they are, will have to be weeded out of the system. Only then real recovery will take place as per us.

This time the rain gods have been way too generous on India. So far, the monsoon has been above average. This creates a platform for good harvest and is likely to keep food inflation under control. However, good monsoon is also bad for India in a certain sense! You may ask how? Well, better monsoon can make our policy makers complacent in fighting the food crisis. Considering the ever increasing population in India, any shortfall in rains even during one season can spark food shortages. In short, good monsoon is not a time to rejoice. But this time should be used more to prepare against droughts that can occur in future. Government data shows that rainfall has been erratic in every 4 out of 10 years. The pattern has also turned unpredictable in recent years. Also, food prices have become more sensitive to monsoons than what they were in the past. All these factors suggest we need to be better prepared to fight drought and thus food inflation. Though overall food production is increasing, population growth has more than offset the rise in production. Thus, government needs to take steps to boost productivity and improve irrigation facilitates.

In the meanwhile, Indian stock markets continued to trade above the dotted line. At the time of writing, the benchmark BSE-Sensex was up by 147 points (0.75%). Information Technology and capital goods stocks were leading the rally. Consumer durables and realty stocks are leading the losses. Asian stock markets were trading mixed with China and Hong Kong facing selling pressure, while Taiwan and Japan traded in the green.

 Today's investing mantra
"The investor's chief problem - and even his worst enemy - is likely to be himself."- Benjamin Graham

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