Saturday 17 September 2011

Irrational & illogical Market??

Do you understand the stock market? You think stock analysts understand the market & that's why they are able to justify the movement with a sound, logical and rational explanation? Yes?
Lets discuss the points further with a few examples from recent times (No, I am not suffering from recency bias but would like to take some vivid {Read- widely discussed and in news for a long time} example).

  • US downgrade by S&P- Rationality would go something like this- US less likely to meet its financial commitments now....Cost of raising new debt should be higher now.. Bond prices should go down.... Yield should go up.  But on the next day of downgrade, yields actually fell !!! WTF!! But, man, you can explain any damn thing. Here is my favourite explanation to the event- The downgrade of Treasurys made people so worried about the elevated risk in the world that they ran to Treasurys for safety. (I don't know he was serious or surprised). I found the explanation extremely hilarious.

  • Lets come to our own Indian markets now. RBI increases repo again. Market says what's repo & moves up. Analysts say hey! This hike was already factored in. Factored In... is another one of the most common explanations used. I have never been able to understand this term. When was it factored in? I mean which day? How much points? Why didn't you tell it then? How do you know? Can you please tell now exactly what all are factored in and what all are not?
As Taleb says if you try hard enough, you can find points supporting your views (Confirmation Bias) and if you try a bit more, you can present a nice, convincing story based on your views and supporting points (Narrative fallacy). But, then presence of one, just one, black swan is enough to conclude - Not all swans are White!!!