Going against the herd

Sixty years ago, the great social psychologist, Solomon Asch, did us a big favour. Through a series of brilliantly conceived experiments, he showed that: (a) most of us suspend belief in our own judgements when confronted by the judgements of a larger group; and (b) we find it hard to disobey the orders of “authority” figures. 

These takeaways can be applied to the stock market as well. In particular, given the mood prevalent in the market today, “conformist” brokerage research (which recycles news clips pertaining to beleaguered companies/sectors and negative commentary by bankers) can easily create adverse herd behaviour in the Indian market. 

My colleagues and I do not agree with much of this negative ‘groupthink’. At the level of the company, the economy and the stock market, our attempt has been cut through the noise, to think rationally and, most importantly, to think for ourselves.

The ‘ctrl C, ctrl V’ club…

Just as in bull markets, when there is no shortage of brokers publishing euphoric thematics about India (complete with professional artwork, glossy covers and hard binding), in bear markets, you struggle to find rational analysis of when the market will turn. Instead, in difficult markets, brokers often choose to rest their pens and pencils, and try to avoid making too many phone calls to clients. When they do pick up their pens, it is often to rehash old news about the companies or sectors, or to narrate personal anecdotes about thinning crowds in shopping malls and the challenges of the white-collar job market.

…and how it hurts investors

Such analysis would not be of import had all of us  — as investors or as market pundits — been rational creatures. Instead, as psychologists have shown graphically over the past 50 years, we let go of our senses at the slightest prompting to do so.

In a series of experiments conducted in the 1950s, Asch demonstrated our frailties. Given a simple task, such as comparing the length of four wooden sticks and pointing out if one of them was the odd one out, people almost never erred when asked to decide on their own (without seeing the judgements of others). However, when put in small groups of, say, five people, when everyone else had been told by Asch to give the incorrect answer, people erred one-third of the time. Thus, even whilst making a simple judgement, individuals were willing to suspend their belief in their own senses and go along with the verdicts of random strangers.

Now suppose the judgement at hand is more complex. For instance, will the economy recover? Will the rupee appreciate? Will the stock market rally? Suppose further that rather than random strangers prompting the answers, the prompting is coming from authority figures — senior bankers, powerful promoters, etc. What effect would that have on us? Asch conducted another set of experiments that sheds light on how our brains react when prompted by authority figures.

In an experiment (originally conducted to understand how perfectly normal people ended up helping the Nazis execute the Holocaust), Asch showed that volunteers were willing to apply fatal electric shocks to those who got quiz questions wrong, provided they were prompted by an authoritative-looking man in a white lab coat to do so.

You can now deduce what happens to most of us when an establishment figure opines in public about the fate of the economy, the current account deficit, the stockmarket, etc. It is in this context that lazy research can drive damaging groupthink on critical matters pertaining to our collective well being.

Multiple dimensions to think about

A fundamentally oriented investor has to think along at least two specific dimensions:

• At the company level, after in-depth research, including primary data checks and forensic analysis where possible, investors need to determine the relative merits of a company without agonising about what the rest of the market makes of the stock. 

• At the economy level, investors need to take a balanced view on the economy, that is, not get swept away by the euphoria of an economic boom or be driven to despair by a downturn. Obviously, this is easier said than done and therein lies the challenge for the contemporary naysayers. 

In fact, if you were to take a long hard rational look at India today, you might be able to find a three-tier positive story, much as my colleagues and I did:

• In a book titled Civilization: The West and the Rest published a year ago, noted historian Niall Ferguson attributed the secular rise of the West across centuries to its ability to develop six killer concepts or ‘apps’ — “competition, science, the rule of law, medicine, consumerism and the work ethic”. At a time when India’s ability to develop on a sustainable basis is being questioned, an analysis of India’s progress on each of these parameters (or ‘killer apps’) provides a useful framework for understanding why India should revert to a high-growth path. In particular, India’s undeniable superiority on ‘Competition’, ‘Consumerism’ and ‘Work Ethic’ is likely to result in India’s eventual reversion to high growth.

• Over the last three months, I have repeatedly highlighted that Indian markets are nearing a significant bottom and that the region around 5,500 on the Nifty should prove to be a strong line of defence for markets, based on our analysis of long-term trends. Following that line of thought, while the sharp run-up in the second half of April may have taken many by surprise, we think this may just be the beginning of a much larger uptrend.

• Psychologists have shown that people who are ‘frustrated and angry’ are likely to choose ‘high-risk high-reward’ gambles. In that context, Indian investors’ outsized bets on gold and real estate make sense! One day, however, this anger will subside and rational thinking on investments will return. That is when the discount of small caps to large caps (a discount that has reached a 10-year high) will start falling.

These are the writer’s personal views