Surviving Year of the Pig: Avoid assumptions in decision-making

Economy January 24, 2019 01:00

By Special to The Nation

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AT THE beginning of each year, investors rush to find as much investment guidance as they can from various well-known financial institutions or market “Gurus” in order to “make money” in the market (hopefully).



Still, given that we all know that the financial market is extremely dynamic, an investment outlook shared at the beginning of the year could prove to be completely wrong as the year closes. 

Let’s flash back to the beginning of 2018 when the market cherished ideas of “global synchronised growth” and “rising emerging market”. Investors might have believed in a brightening earnings outlook for equities, especially EM equities. However, the EM market actually went down about 14 per cent. 

Rapid change in market outlook seems to have been carried on to this year. One can now see the seeds of uncertainties, including the unclear US-China trade tension, global economic slowdown, “global liquidity outflows” from quantitative tightening (QT) and political uncertainty around the globe. 

Therefore, outlook alone cannot save your investment from a volatile and eventful market. This is especially so when it is intensified by human heuristic biases, which occur when the brain takes shortcuts to solve a problem. However, those shortcuts may sometimes be suboptimal – or even illogical. 

Two of the most common biases are confirmation bias and anchoring bias.

If, at the beginning of 2018, you were a diehard Apple investor and someone told you that Apple’s earnings growth would deteriorate tremendously from 30 per cent to 2 per cent in 2019, would you have believed that person and sold your Apple stocks? 

You were more likely to “anchor” your decision at holding Apple stocks. You might think the company still had new products lined up, along with lots of avid Apple fans. There was no way Apple stock would go down, you might think.

Even when you heard about Apple’s suppliers cutting their earnings forecasts, or a Chinese purchasing power drop leading to weak demand for Apple’s products, you would still find counterarguments to “confirm” your view. For example, a number of stock analysts still recommended buying Apple stocks with an alluring target price. Once the price went down, you might still find reasons to buy even more Apple shares due to their compellingly cheap P/E ratio given their shining growth stories. 

In contrast to your anchored belief about the vivifying future of Apple, the company’s stocks went down over 30 per cent in just three months after Apple’s CEO cut their sales guidance for the first time in 15 years. As a result, you – who made a decision not to sell Apple shares – are suffering from a tremendous loss due to your Anchoring Bias and Confirmation Bias.

Now let’s think about a case in which a lot of people fell into the heuristics trap. One prominent example is the most recent cryptocurrency bubble (as well as other historical bubbles). When investors anchored their decisions on the exponential growth of cyptocurrencies’ adoption, more and more investors (regardless of being amateurs or professionals) will find additional confirmation to reassure their views. Hence, few investors listen to any warnings about the cryptocurrency bubble until the bubble bursts. 

Heuristic errors are as unavoidable as they are innate. Yet, investors should recognise that these biases exist and be aware of them when making investment decisions. For instance, investors should always find “dissenting voice of reason” so you could discover any loopholes in your investment thesis. Additionally, investors could implement a solid framework for investing or even utilise systematic trading and algorithmic trading. Surprisingly, “quant” hedge funds – which invest based on their computerised codes – beat traditional hedge funds by meaningful margins last year. For example, Ray Dalio’s flagship Pure Alpha fund returned 14.6 per cent net of fees in 2018, a year full of market turmoil. 

Views expressed in this article are those of the authors and not necessarily of TMB Bank or its executives. 

Contributed by DUANGRAT PRAJAKSILPTHAI and POON PANICHPIBOOL. They can be reached at tmbanalytics@tmbbank.com

 

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