Tag: John Allen Paulos | Page 2

9 January, 2015

The stories that business media and market analysts tell us

Vivek Kaul

Over the last few days I have had great fun watching business news channels. After the BSE Sensex crashed by 855 points or over 3% on January 6, 2015, all kinds of explanations have been offered for the fall by the business media in general and market analysts in particular. Greece will soon be in major trouble. The dollar is rising against other currencies. The global cues are not good. Oil price has fallen to below $50 per barrel. This means that the world is entering an era of deflation (Deflation, a scenario of falling prices, is the opposite of inflation, and I am amazed how easily market analysts who appear on television use this term). The Modi effect is slowing down. The foreign investors need to realign their portfolios with the changing global economic scenario. And the proverbial, Indian economy is not doing well and corporate investment is needs to pick up. Two days later on January 8, 2015, the Sensex rallied 366 points or 1.4%. Market analysts and the business media told us that value buying was now coming in and this had led to the rally. What amazes me is that investors suddenly saw value in stocks with the market falling by just 3%? Benjamin Graham must be turning in his grave. He clearly never would have envisaged a day like this. Also, the investors did not see value on January 7, 2015, when the Sensex was almost flat. It fell by around 78.6 points or 0.3% on that day. But they suddenly saw value on January 8, 2015. What changed overnight? That no market analyst bothered to explain. In the Indian context, the foreign institutional investors have been driving the market for a while now. On January 6, 2015, they net sold stocks worth Rs 1,534.23 crore. But this was neutralized to some extent by domestic institutional investors buying stocks worth Rs 1,079.6 crore on the same day. Markets go up. Markets go down. And just because analysis exists doesn’t mean we analyse everything. I haven’t heard a single market analyst or a journalist in the business media till date say that today’s stock market movements were due to random fluctuations. As John Allen Paulos writes in A Mathematician Reads the Newspaper: “Almost never does a stock pundit say that market’s or a particular stock’s activity for the day or the week or the month was largely a result of random fluctuations.” With so many numbers and stories going around it is always possible to say something which on the face of it sounds very sensible. “The business pages, companies’ annual reports, sales records, and other widely available statistics provide such a wealth of data from which to fashion sales pitches that it’s not difficult for a stock picker to put on a good face…All that’s necessary is a little filtering of the sea of numbers that washes over us,” writes Paulos. This is precisely what has been happening over the last few days. The information and analysis being provided is essentially adding to the clutter. As Nassim Nicholas Taleb writes in Fooled by Randomness: “The difference between noise and information…has an analog: that between journalism and history. To be competent, a journalist should view matters like a historian, and play down the value of the information, he is providing.” This Taleb, feels can be done by saying: “Today the market went up, but this information is not too relevant as it emanates from noise”. But in an era of 24 hour news channels this is easier said than done. “Not only is it difficult for the journalist to think more like a historian, but it is, alas, the historian who is becoming more like the journalist [and to add my two bit so are market analysts]…If there is anything better than noise in the mass of “urgent” news pounding us, it would be like a needle in a haystack. People do not realize that the media is paid to get your attention. For a journalist, silence really surpasses any word,” writes Taleb. To be fair to the business news channels, the business newspapers follow the same formula of trying to come up with an explanation for market movements all the time. It’s just that since they do not have to react instantly to everything, some amount of noise gets filtered out in their reporting. A few years back I happened to interview valuation guru Aswath Damodaran and asked him a fairly straightforward question: How much role does media play in influencing investment decisions of people? The reply he gave was very interesting: “Media and analysts are followers…Basically when I see in the media news stories I see a reflection of what has already happened. It is a lagging indicator. It is not a leading indicator. I have never ever found a good investment by reading a news story. But I have heard about why an investment was good in hindsight by reading a news story about it. I am not a great believer that I can find good investments in the media. That’s not their job anyway.” This is something that investors need to keep in mind while following the media in their quest to understand why are the markets moving the way they are. It is worth remembering that business news channels and the business newspapers need to operate even when there is no major news. As Maggie Mahar writes in Bull—A History of the Boom and Bust, 1982-1984: “The perennial problem for the media is that balance sheets do not fluctuate on a daily basis. Once a reporter has laid out a company’s assets and debts, how does he fill the news hole the next day? Only by tracking market’s daily performance.” Analysts help the business press in filling up the daily space. This is something that former Morgan Stanley analyst Andy Kessler writes about in his book Wall Street Meat: “The market opens for trading five days a week… Companies report earnings once every quarter. But stocks trade about 250 days a year. Something has to make them move up or down the other 246 days [250 days – the four days on which companies declare quarterly results]. Analysts fill that role. They recommend stocks, change recommendations, change earnings estimates, pound the table—whatever it takes for a sales force to go out with a story so someone will trade with the firm and generate commissions.” And once analysts have a daily opinion, the media gets some masala to fill up its daily space. The trouble is that while the media ends up filling up space, investors who follow the media are bound to end up confused if they follow the media on a daily basis. It is worth remembering here what hedge fund manager Bill Fleckenstein told Mahar: “The trouble is that investing doesn’t lend itself to play-by-play reporting…Speculation does, but investing doesn’t.” The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 9, 2015

19 March, 2014

What is the right price of anything?

Vivek Kaul
A few years back when I went to get a new pair of spectacles made, I was given an estimate of Rs 5,700. “Chashma khareedna hai, dukan nahi (I want to buy a pair of spectacles, not the shop),” I quipped immediately.
The shopkeeper heard this and quickly moved into damage control mode. He showed me a new frame and we finally agreed on a price of Rs 2,700. The frame I ended up buying was not very different from the one that I had originally chosen. The shopkeeper tried to tell me that the earlier one was more sturdy, easy on the eyes, etc.
But to me both the frames looked the same. I have thought about this incident a few times since it happened, and come to the conclusion, that the shopkeeper was essentially trying to figure out the upper end of what I was ready to pay. In the end he sold me more or less the same product for Rs 2,700 even though he had started at Rs 5,700. He was playing mind games.
Was he successful at it? Prima facie it might seem that I saved Rs 3,000. (Rs 5,700 minus Rs 2,700). But is that the case? One of the selling tricks involves making the customer feel that he has got a good deal. Barry Schwartz provides a excellent example of this phenomenon in his book The Paradox of Choice: Why More is Less.
He gives the example of a high-end catalog seller who largely sold kitchen equipment. The seller offered an automatic bread maker for $279. “Sometime later, the catalog seller began to offer a large capacity, deluxe version for $429. They didn’t sell too many of these expensive bread makers, but sales of the less expensive one almost doubled! With the expensive bread maker serving as anchor, the $279 machine had become a bargain,” writes Scwartz.
Now compare this situation to what I went through. Before you do that, let me give you one more piece of information. When I went to the shop looking to buy a pair of spectacles, I had thought that I won’t spent more than Rs 2,000 on it. But I ended up spending Rs 2,700.
The shopkeeper’s first prize of Rs 5,700 gamed me into thinking that I was getting a good price. Thus, I ended up spending Rs 700 more than what I had initially thought. Behavioural economists refer to this as the “anchoring effect”. As John Allen Paulos writes in A Mathematician Plays the Stock Market “Most of us suffer from a common psychological failing. We credit and easily become attached to any number we hear. This tendency is called “anchoring effect”.”
Marketers use “anchoring” very well to make people buy things that they normally won’t. As Schwartz points out “When we see outdoor gas grills on the market for $8,000, it seems quite reasonable to buy one for $1,200. When a wristwatch that is no more accurate than one you can buy for $50 sells for $20,000, it seems reasonable to buy one for $2,000. Even if companies sell almost none of their highest-priced models, they can reap enormous benefits from producing such models because they help induce people to buy cheaper ( but still extremely expensive) ones.”
Anchoring is used by insurance agents as well to get prospective customers to pay higher premiums than they normally would. As Gary Belsky and Thomas Gilovich write in Why Smart People Make Big Money Mistakes and How to Correct Them “If you’re on the “buy side” purchasing life insurance, for example you’ll be susceptible to any suggestions about normal levels of coverage and premiums. All that an enterprising agent need to tell you is that most of people at your age have, say, $2 million worth of coverage, which needs $4,000 a year and that will likely become your starting point of negotiations.”
Hence, it is important for consumers seeking a good deal to keep this in mind, whenever they are thinking of buying something.
The column originally appeared in the Mutual Fund Insight magazine, March 2014
(Vivek Kaul is the author of Easy Money. He can be reached at [email protected])

12 November, 2012

Gambler’s fallacy: The lesson I learnt last Diwali

Kyon daren zindagi main kya hoga, kuch na hoga to tajurba hoga’ – Javed Akhtar (tajubra = experience)
Experience is a great teacher, but the trouble is it only comes with time, and by then the mistakes have already been made.
Last Diwali I played teen patti for the first time with friends and family. I started cautiously with a hundred rupees bet. But with the beginners luck at work I easily won the next few rounds and half an hour later I had won Rs 5,000 and was now worth Rs 5,100 in total, which included the Rs 100 I had started with as well.
Then egged on by sister I bet the entire Rs 5,100 blind, on the tenth round that we were playing. And against the luck of the draw, I lost.
I turned around wanting to look at my sister, but before I could say anything i.e. call her names she said “Don’t worry bhaiyya you just lost a hundred rupees.”
Now did I? Was that really the case? Or was something else at work?
Following the time tested method of when in doubt then Google, I came to realise that I had just become a victim of what behavioural economists (a section of economists who link human psychology to economics) call “mental accounting”.
Richard Thaler, a pioneer in the field of Behavioural Economics and who coined the term mental accounting, defines it as “the inclination to categorise and treat money differently depending on where it comes from, where it is kept and how it is spent.”
This leads to what is referred to as the gambler’s fallacy, the tendency of gamblers who lose their winnings, feeling that they haven’t lost anything at all. Precisely, like what my sister said.
Thaler along with Cass Sunstein explains this in his book Nudge — Improving Decisions About Health, Wealth and Happiness. “You can also see mental accounting in action at the casino. Watch a gambler who is lucky enough to win some money early in the evening. You might see him take the money he has won and put it into one pocket and put the money he brought with him to gamble that evening (yet another mental account) into a different pocket,” write the authors.
The gamblers call their winnings ‘house money’. As the authors write “The money that has recently been won is called ‘house money’ because in the gambling parlance the casino is referred to as the house. Betting some of the money that you have just won is referred to as ‘gambling with the house’s money’; as if it was, somehow, different from some other kind of money. Experimental evidence reveals that people are more willing gamble with money that they consider house money.”
The house money effect is even seen at work when stock markets are on an upside. Thaler and Sunstein, give the example of the late 1990s when the world was seeing the dotcom bubble. “Mental accounting contributed to the large increase in stock prices in the 1990s, as many people took on more and more risk with the justification that they were playing only with their gains from the last few years,” they write.
It isn’t only while gambling and investing in stock markets that human beings categorise money in different ways. As John Allen Paulos writes in A Mathematician Plays the Stock Market “People who lose a $100 ticket on the way to a concert, for example, are less likely to buy a new one than are people who lose $100 in cash on their way to buy the ticket. Even though amounts are the same in the two scenarios, people in the former one tend to think $200 is too large an expenditure from their entertainment account and so don’t buy a new ticket, while people in the latter tend of assign $100 to their entertainment account and $100 to their “unfortunate loss” account and buy the ticket.”
Or sample this situation. Let’s say you are at an electronics shop looking to buy a laptop. You finally decide to buy a model which costs around Rs 36,300. Just as you are paying for it a friend calls and tells you about a better deal on a website which is offering the same model for Rs 36,000? Will stop the purchase and go back home and order the laptop from the website? The chances are no.
But consider another situation where you are out looking to buy a DVD player. You finally zero down on a model that costs Rs 3000. At that point of time a friend calls and tells you that the same thing is available on a website for Rs 2700. Will you stop the purchase and go back home and order the DVD player from the website? The answer is yes.
The funny thing is that in both the cases you would have saved Rs 300. But in one case you decided to go ahead with the transaction and in another case you did not? Why does this happen? At a fundamental level the Rs 300 we save is being categorised into different mental accounts because we are thinking in terms of percentages. Rs 300 expressed as a percentage of Rs 36,300 is very small whereas Rs 300 expressed as a percentage of Rs 3000 is significantly larger.
This tendency to categorise money into different mental accounts leads to several other interesting situations. Money that comes in rather unexpectedly, like a tax refund, a salary arrear, a higher than expected bonus at the end of the year, or a generous cash gift from a visiting relative for that matter, gets spent faster.
As Gary Belsky and Thomas Gilovich point out in their book Why Smart People Make Big Money Mistakes and How to Correct Them “Consider tax refunds, for example. Many people categorise such payments from the government as found money – and spend it accordingly – even though a refund is nothing more than a deferred payment of salary. Forced savings, if you will. If, on the other hand, those same people had taken that money out of their paycheck during the course of the previous year …they would most likely think long and hard before spending it on a new suit or Jacuzzi.”
This also leads to a situation where people have personal loans or huge credit card balances outstanding even though they have money lying in the bank earning nterest in the savings account or in the form of a fixed deposit. This despite the fact that the interest earned on a fixed deposit is much lower than the interest being paid on a personal loan or credit card balance outstanding.
In fact research has been carried out to show precisely this. “David Gross and Nick Souleles (2002) found that the typical household in the sample of Americans had more than $5,000 in liquid assets (typically in savings accounts earning less than 5% per year) and nearly $3,000 in credit card balances, carrying a typical interest rate of 18% or more,” write Thaler and Sunstein. Now wouldn’t it have been much simpler to pay off the credit card debt instead of paying such a high rate of interest on it?
But mental accounting is at work. People put the loan outstanding into the loan mental account whereas money in the bank gets categorised as a savings mental account. And the two do not meet. As the Thaler and Sunstein write, “Many of these households have borrowed up to the limits that their credit cards set. They may realise that if they paid off the credit card debt from the savings account, they would soon run up the cards to their limits once again. (And credit card companies, fully aware of this, are often more than willing to extend more credit to those who reached the limit, as long as they aren’t yet falling behind on interest payments.”
Hence it is important to remember that money is fungible. So there is no point in having money lying in a fixed deposit while you are still paying off your credit card balance or a personal loan for that matter. The interest you earn on your fixed deposit will be always lower than the interest you pay on your credit card debt or on a personal loan. Given this it makes more sense to first and foremost pay off your debts instead of saving money while categorising it into a “mental account”.
If all this wasn’t enough, have you ever wondered why shops and malls actually accept payments made through credit and debit cards, even though they do not get the full price on those transactions? Well the answer again comes back to mental accounting.
As Belsky and Gilovich point out, “In fact, credit cards…are almost by definition mental accounts, and dangerous ones at that. Credit card dollars are cheapened because there is seemingly no loss at the moment at the purchase, at least on a visceral level. Think of it this way: If you have $100 cash in your pocket and you pay $50 for a toaster, you experience the purchase as cutting your pocket money in half. If you charge that toaster though, you don’t experience the same loss of buying power that your wallet of $50 brings.”
Given this, while shopping most individuals end up paying more when they use their credit cards. And that explains why shops accept credit cards happily even though they get paid only around 98% of the price of what is purchased. But they benefit because the size of the purchase goes up.
If you still haven’t understood what mental accounting is all about here is a brilliant example that Thaler and Sunstein talk about. “The concept is beautifully illustrated by an exchange between Gene Hackman and Dustin Hoffman. Hackman and Hoffman were friends back in their starving artist days, and Hackman tells the story of visiting Hoffman’s apartment and having his host ask him for a loan. Hackman agreed to the loan, but then they went into Hoffman’s kitchen, where several mason jars were lined up on the counter each containing money. One jar was labelled ‘rent,’ another ‘utilities,’ and so forth. Hackman asked why, if Hoffman had so much money in jars, he could possibly need a loan, whereupon Hoffman pointed to the food jar, which was empty.”
The article originally appeared on www.firstpost.com on November 12, 2012.
Vivek Kaul is a writer. He can be reached at [email protected]