John Kenneth Galbraith

Why Robots Are Not Going to Screw Humans-At Least Not Yet

Sony_Qrio_Robotot

If you are the kind who reads the inside pages of newspapers carefully, you would know that these days stories around robots replacing human jobs are quite common. Most of these stories are written in a way that suggest that doomsday is upon us.

But is it as straightforward as the newspapers and the media makes it out to be? I really don’t agree. I had first written about this issue a few months back in the weekly Letter that I write, but given the importance of the issue, I am sharing my thoughts with the Diary readers as well.

In the recent past, there have been a spate of headlines in the media on the capabilities of robots having reached a stage wherein they can take on human jobs. Here are a few news items, along these lines, which I have come across over the last few months.

1) In May 2016, the shoemaker Adidas announced that it would start manufacturing shoes in its home country of Germany after nearly two decades. But it shall use robots and not human beings to do the same. The company calls its robot factory the speed factory. A second such factory is being planned in the United States as well.[i]

2) In another similar case, Foxconn, a company which manufactures mobile phones for both Samsung and Apple, is replacing 60,000 workers with robots.[ii]

3) In July 2016, HfS Research, a research firm based in the United States, predicted that by 2021, India’s information technology companies will lose around 6.4 lakh jobs to automation. This is something that high ranking officials of Indian IT firms have also said.

4) In mid-September 2016, the textile major Raymond said that it was planning to slash 10,000 jobs across its manufacturing centres all across India and replace them with robots and technology. The company currently employs 30,000 employees.[iii] Hence, robots are likely to replace one-third of its workforce.

5) Driverless cars have already arrived. As Ruchir Sharma writes in The Rise and Fall of Nations—Ten Rules of Change in the Post-Crisis World: “The most common job for American men is driving, and one forecast has driverless smart cars and trucks replacing them all by 2020.”[iv]

6) And if all this wasn’t enough, on October 3, 2016, the World Bank President Jim Yong Kim said in a speech: “Research based on World Bank data has predicted that the proportion of jobs threatened by automation in India is 69 percent, 77 percent in China and as high as 85 percent in Ethiopia.”[v]

These are just a few examples of the expectation that robots will take over human jobs that I have come across over the last few months. As can be seen, this threat looms not just over India but over large parts of the developed as well as the developing world.

As Rutger Bergman writes in Utopia for Realists: “Scholars at Oxford University estimate that no less than 47 per cent of all American jobs and 54 per cent of those in Europe are at the high risk of being usurped by machines. And not in a hundred years or so, but in next twenty years.” He then quotes a New York university professor as saying: “The only real difference between enthusiasts and skeptics is a time frame.”[vi]

Indeed, the threat of robots taking over human jobs is nothing new. So what makes the threat this time around so different from the previous ones? As Yuval Noah Harari writes in Homo Deus—A Brief History of Tomorrow: “This is not an entirely new question. Ever since the Industrial Revolution erupted, people feared that mechanisation [which is what robots are after all about] might cause mass unemployment. This never happened, because as old professions became obsolete, new professions evolved, and there was always something humans could do better than machines. Yet this is not a law of nature and nothing guarantees it will continue to be like that in the future.”[vii]

The question is: What has changed this time around?

Human beings essentially have two kinds of abilities: a) physical ability b) cognitive abilities i.e., the ability to think, understand, reason, analyse, remember, etc. As Harari writes: “As long as machines competed with us merely in physical abilities, you could always find cognitive tasks that humans do better. So machines took over purely manual jobs, while humans focussed on jobs requiring at least some cognitive skills. Yet what will happen once algorithms outperform us in remembering, analysing and recognising patterns?”

Hence, the robots used until now essentially replaced the physical things that human beings did in factories. The trouble is that now the robots have also started thinking (in the form of algorithms) and hence, many more human jobs are on the line. Harari feels that “as algorithms push humans out of the job market, wealth might become concentrated in the hands of the tiny elite that owns the all-powerful algorithms, created unprecedented social inequality.”

This argument along with the evidence offered before seems to be pretty convincing, if seen in isolation. But there is a lot more to this than just the evidence that is currently being offered. As Sharma writes: “While the robotics revolution could come faster than most previous technology revolutions, it is likely to be gradual enough to complement rather than destroy human workforce. A huge gap still exists between the size of the world’s industrial robot population—about 1.6 million—and the global industrial labour force of about 320 million humans. Most of the industrial robots are currently unintelligent machines, committed to a single task like turning a bolt or painting a car door, and indeed half of them work in the car industry.”[viii]

As per the International Federation of Robots, South Korea currently has the highest penetration of robots. The country has 437 robots per 10,000 employees. Japan and Germany come in second and third with 323 robots and 282 robots per 10,000 employees, respectively. China has 14 robots per 10,000 employees.[ix]

The point is that there aren’t as many robots going around as there are made out to be. Also, it is worth remembering here that large parts of the Western world and Japan are currently seeing their population decline. China will also soon reach that stage as well. Hence, in that sense the robots will arrive at the right time replacing the decline in the labour force. As Daniel Kahneman the Noble Prize winning psychologist (he won the Economics prize) told John Markoff, a journalist, who covers science and technology for The New York Times: “You just don’t get it…In China, the robots are going to come just in time.”[x]

The point is that when it comes to big predictions like robots taking over human jobs, there are always a few ifs and buts. The trouble is that these ifs and buts are not being highlighted as much as the core argument of robots taking over human jobs, currently is.

Other than these factors there is a basic law in economics which goes against the entire idea of robots totally destroying human jobs. It’s called the Say’s Law. One of my favourite books in economics is John Kenneth Galbraith’s A History of Economics—The Past as the Present (In fact, anyone who wants to understand economics should mandatorily make Galbraith a part of his readings). In A History of Economics, Galbraith writes about the Say’s Law.

This law was put forward by Jean-Baptise Say, a French businessman, who lived between 1767 and 1832. As Galbraith writes: “Say’s law held that out of the production of goods came an effective aggregate of demand sufficient to purchase the total supply of goods. Put in somewhat more modern terms, from the price of every product sold comes a return in wages, interest, profit or rent sufficient to buy that product. Somebody, somewhere, gets it all. And once it is gotten, there is spending up to the value of what is produced.”

Say’s Law essentially states that the production of goods ensures that the workers and suppliers of these goods are paid enough for them to be able to buy all the other goods that are being produced. A pithier version of this law is, “Supply creates its own demand.”

As Bill Bonner writes in Hormegeddon—How Too Much of a Good Thing Leads to Disaster: “French businessman and economist, Jean-Baptiste Say, discovered that “products are paid for with products,” not merely with money. He meant that you needed to produce things to buy things.”

So what does this mean in the context of robots destroying human jobs? If robots destroy too many human jobs, many people won’t have a regular income. If these people do not have a regular income, how are they going to buy all the products that robots are going to produce? And if they are not going to buy the products that robots are producing, how are these companies driven by robots going to survive?

This is a basic question that none of the analysts, who are predicting doom on the basis of robots taking over human jobs, have bothered to ask. For capitalism to survive, it is essential that human beings work and earn an income, only then can they go around buying everything that is being produced.

The basic problem with the robots taking over human jobs argument is best explained through this example. As Bergman writes: “When Henry Ford’s grandson [Henry Ford II] gave labour union leader Walter Reuther a tour of the company’s new, automated factory, he jokingly asked, “Walter, how are you going to get those robots to pay your union dues?” Without missing a beat, Reuther answered, “Henry, how are you going to get them to buy your cars?””[xi]

Also, another point that most analysts seem to miss is that if and when robots actually do start destroying many human jobs, it is stupid to assume that the governments will sit around doing nothing. There will be huge pressure on them to react and make it difficult for companies to replace human beings with robots.

To cut a long story short, it will be interesting to see how the robots taking over human jobs trend evolves in the years to come, but it will not be as straightforward as it is currently being made out to be.  If we are still in business, we will surely keep a lookout!

The column originally appeared in Equitymaster on January 25, 2017

[i] Agence France-Presse, Reboot: Adidas to make shoes in Germany again – but using robots, May 25, 2016

[ii] J.Wakefield, Foxconn replaces ‘60,000 factory workers with robots’, BBC.com, May 25, 2016

[iii] TNN and Agencies, Raymond to replace 10,000 jobs with robots in next 3 years, September 16, 2016

[iv] R.Sharma, The Rise and Fall of Nations—Ten Rules of Change in the Post-Crisis World, Allen Lane, 2016

[v] Speech by World Bank President Jim Yong Kim: The World Bank Group’s Mission: To End Extreme Poverty, October 3, 2016

[vi] R.Bergman, Utopia for Realists—The Case for a Universal Basic Income, Open Borders and a 15-Hour Workweek, The Correspondent, 2016

[vii] Y.N.Harari, Homo Deus—A Brief History of Tomorrow, Harper, 2016

[viii] Sharma 2016

[ix] Ibid

[x] A Conversation With John Markoff. Available at https://www.edge.org/conversation/john_markoff-the-next-wave. Accessed on October 12, 2016

[xi] Bergman 2016

 

What India Inc needs to understand about interest rates

CII_Logo

Vivek Kaul


Big business has been after the Reserve Bank of India (RBI) to cut the repo rate or the rate at which the central bank lends money to the banks.
There seems to be a certain formula to the whole thing. Before any monetary policy the business lobbies make a series of statements asking the RBI to cut interest rates. And when the RBI does not cut the repo rate, they make another series of statements explaining why the RBI should have cut the repo rate.
The belief is that a cut in the repo rate will lead to banks cutting the interest rates at which they lend. The statements made by the business lobbies normally try to explain how a cut in interest rates will lead to people borrowing and consuming more and companies borrowing and investing more. The RBI hasn’t entertained them till now.
In the monetary policy statement released on December 2, 2014, the RBI said that it might start cutting the repo rate sometime early next year.
The business lobbies immediately issued statements expressing their disappointment on the RBI not cutting the repo rate. Confederation of Indian Industries (CII), one of the three big business lobbies, said in a statement: “At this juncture, even a symbolic cut in policy rates would have sent a strong signal down the line that both the government and the RBI are acting in concert to harness demand and take the economy to the higher orbit of growth.”
The phrase to mark here is harness demand (which I have italicized). As explained earlier the logic is that when the RBI cuts the repo rate, banks will cut their lending rates as well and people will borrow and spend more. This will mean businesses will earn more and will lead to economic growth.
Only if it was as simple as that: .
As John Kenneth Galbraith writes in The Affluent Society: “Consumer credit is ordinarily repaid in instalments, and one of the mathematical tricks of this type of repayment is that a very large increase in interest brings a very small increase in monthly payment.” And vice versa—a large cut in interest rate decreases the monthly payment by a very small amount.
Let’s understand this through an example. An individual decides to take a car loan of Rs 4.5 lakh at 10.5%, repayable over a period of five years. The monthly payment or the EMI on this loan amounts to Rs 9,672. Now let’s say the RBI decides to cut the repo rate by 50 basis points (one basis point is one hundredth of a percentage).
The bank works in perfect coordination with RBI (which is not always the case) and decides to cut the interest loan on the car loan by 50 basis points to 10%. The new EMI now stands at Rs 9,561 or around Rs 111 lower.
If the interest rate is cut by 100 basis points to 9.5%, the EMI falls by around Rs 221.5. Hence, a nearly one tenth cut in interest rate (from 10.5% to 9.5%) leads to the EMI falling by around 2.3% (Rs 221.5 expressed as a percentage of Rs 9,672, the original EMI).
Now will people go and buy cars just because the EMI is Rs 111 or Rs 221.5 lower? Obviously not. People spend money when they feel confident about their economic future. And that is not just about lowering interest rates.
For loans of smaller ticket sizes (consumer durables, two wheeler loans etc.) the difference between EMIs when interest rates are cut, is even more smaller. Hence, the logic that a cut in interest rates increases borrowing, isn’t really correct. As Galbraith puts it: “During periods of active monetary policy, increased finance charges have regularly been followed by large increases in consumer loans.”
What about the corporates? The business lobby CII felt that if the RBI had cut interest rates it would have “improved the poor credit offtake by industry”. In simple English this means that corporates would have borrowed and invested more, only if, the RBI had cut the repo rate.
But is that really the case? As John Kenneth Galbraith points out in The Economics of Innocent Fraud: “If in recession the interest rate is lowered by the central bank, the member banks are counted on to pass the lower rate along to their customers, thus encouraging them to borrow. Producers will thus produce goods and services, buy the plant and machinery they can afford now and from which they can make money, and consumption paid for by cheaper loans will expand.”
But that doesn’t really happen. “The difficulty is that this highly plausible, wholly agreeable process exists only in well-established economic belief and not in real life. The belief depends on the seemingly persuasive theory and on neither reality nor practical experience. Business firms borrow when they can make money and not because interest rates are low [the emphasis is mine],” Galbraith points out.
The last sentence in the above paragraph summarizes the whole situation. And it is difficult to believe that corporates do not understand something as basic as this.
This was also pointed out in a recent research report titled Will a rate cut spur investments?Not really, brought out by Crisil Research. (I had referred to this report in detail on an earlier occasion).
In this report it was pointed out that investment growth in fiscals 2013 and 2014 fell to 0.3%, despite negative real interest rates (repo rate minus retail inflation). The real interest rate during the period was at minus 2.1%, whereas the real lending rate was only at 2.8%.
In contrast for the period between 2004 and 2008, had a real interest rate of 7.4%, and the average investment growth stood at 16.4% per year, during the period. Why was that the case? “The rate of return on investments – as proxied by return on assets (RoA) of around 10,000 non-financial companies as per CMIE Prowess database – have fallen sharply to 2.8% in fiscal 2013 and 2014 from 5.9% in the pre-crisis years,” Crisil Research points out.
This is precisely the point Galbraith makes— Business firms borrow when they can make money and not because interest rates are low.
To conclude, Indian businesses seem to have great faith in monetary policy doing the trick, when there are too many other factors holding back growth (I haven’t gone into these factors partly because they are well known and partly because that’s a separate column in itself).
Indian businessmen are not the only ones who seem to have great faith in monetary policy. This is a trend that is prevalent throughout the world. The central bankers are expected to use monetary policy and come to the rescue of the beleaguered economies all over the world.
Where does this faith stem from? Galbraith explains this beautifully in The Affluent Society: “There is no magic in the monetary policy…[It] is a blunt, unreliable, discriminatory and somewhat dangerous instrument of economic control. It survives in esteem partly because so few understand it…It survives, also because active monetary policy means that, at times, interest rates will be high – a circumstance that is far from disagreeable for those with money to lend.”

The article appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 8, 2014

Nifty 10,000: Coming soon at a stock market near you

bullfightingVivek Kaul

It is that time of the year when the stock market analysts get busy predicting what levels do they see Sensex/Nifty reaching during the course of the next financial year.
First off the blocks this year are Gautam Chhaochharia and Sanjena Dadawala of UBS Global Research, who have predicted that the NSE Nifty will touch 9,600 points by the end of 2015. As I write this, the Nifty is trading at around 8375 points. Hence, the UBS analysts are basically talking about the Nifty index, rallying by around 15% over the course of the next thirteen and a half months by end 2015.
The prediction of 9,600 points has been arrived at by making certain assumptions, including the expectation of earnings of companies growing by 15% during the course of the next financial year (i.e. the period between April 1, 2015 and March 31, 2016).
Over the next few weeks you will see a spate of analysts of making such predictions. And it won’t be surprising if someone comes up with a Nifty target of 10,000 points or more. For one, saying that Nifty will touch 10,000 points is inherently more sexier than saying Nifty will touch 9,600 points. A big round number always sounds so much better.
Further, Nifty at 10,000 points will be around 19.4% higher than the current level of 8375 points. It has rallied by 32.6% during the course of this year (from January 2014 to November 13, 2014). Hence, a rally of 19.4%, assuming that Nifty will touch 10,000 by end 2015, sounds pretty reasonable.
Nevertheless, the question is how do these analysts know? John Kenneth Galbraith explains this in his book The Economics of Innocent Fraud. As he writes “The fraud begins with a controlling fact, inescapably evident but universally ignored. It is that the future of economic performance of the economy, the passage from good times to recession or depression and back, cannot be foretold. There are more ample predictions but no firm knowledge.”
And why is that ?“There is the variable effect of exports, imports, capital movements and corporate, public and government reaction thereto. Thus the all-too-evident-fact: The combined result of the unknown cannot be known,” writes Galbraith.
Nevertheless, these predictions serve a useful purpose. They tell people what they want to hear, especially during a bull market, when share prices are going up and people are inherently optimistic about things. As Galbraith puts it “The men and women so engaged[i.e. the ones making the predictions] believe and are believed by others to have knowledge of the unknown; research is thought to create such knowledge. Because what is predicted is what others wish to hear and what they wish to profit or have some return from, hope or need covers reality.”
The stock market rally this year has been more about “easy money” from abroad coming into India, rather than any fundamental improvement in economic activity. Since the beginning of the year (and upto November 13,2014) foreign institutional investors have made a net investment of Rs 67,359.4 crore into the Indian stock market.
This has largely been on account of Western central banks maintaining low interest rates. Hence, foreign investors have been able to borrow money at low interest rates and invest it in the Indian stock market. The inflows have been particularly strong since May, when Narendra Modi came to power. Since May 2014, Rs 35,545.7 crore has been the net investment made by FIIs in India.
The basic point is that in an environment where easy money is essentially driving up stock prices, predictions are more about understanding investor psychology than the underlying fundamentals of the market.
An excellent analogy here is that of Henry Blodget, who used to work as a senior analyst with the Wall Street firm CIBC Oppenheimer, in the late 1990s. In October 1998, Blodget brought out a report on Amazon.com. In this report he had predicted that the stock would go past $150 in a year’s time. He had also added in that report that the stock was worth anywhere between $150 and $500. At that point of time, the stock was quoting at $80. The stock raced past Blodget’s one-year target within a few weeks, so huge was the flow of money into the stock market.
His sales team then began to pester him for a new target. By December 1998, the price of the Amazon stock had crossed $200. As Maggie Mahar recounts in Bull!—A History of the Boom and Bust, 1982–2004 “Privately, he[Blodget] was confident that Amazon would hit $400—he just didn’t know if he had the balls to say it. But as his very first boss on Wall Street had told him, “You’re not a portfolio manager—you‘re not trying to sneak quietly into a stock before someone else sees it. You’re an analyst: your job is to go out and take a position.”
And that is what Blodget did. He took the position that Amazon would hit $400 within a year’s time. There must have been hundreds of other analysts on Wall Street who could have said the same thing. It was just that Blodget had the balls to say the right thing at the right time. He told the stock market what it wanted to hear.
Blodget put out his recommendation of Amazon hitting $400 on December 16, 1998. Within minutes, his forecast was traveling around the world. A Bloomberg reporter got a tip and put out the story. Soon, CNBC picked it up. And in no time, the recommendation had hit the chat boards across the various internet sites. And once that happened, the stock simply went through the roof. Amazon, which had closed at a price of $242.75 on December 15, 1998, closed 19 percent higher at $289 on December 16, 1998.
After this, the price of Amazon went on a roll. The stock was split in early January 1999, and the price crossed the $400 level that Blodget had predicted in March 1999, in split adjusted terms. Blodget got the investor psychology right. At some level, Blodget understood that he was in the midst of a stock market driven more by emotion and momentum. Hence, more than the price of the stock, he had to predict investor psychology and where that could take the price.
The Indian stock market is going through a similar era of easy money right now, though of a lower degree in comparison to the dot-com bubble that was on in the United States in the late 1990s. Hence, making predictions is going to about predicting investor psychology than the underlying fundamentals.
Given this, it won’t be surprising to see forecasts predicting that Nifty will cross 10,000 points next year, coming out over the next few years. Of course all these forecasts will indulge in what American writer Steven Pinker calls “compulsive hedging”. As he writes in his new book The Sense of Style “Many writers cushion their prose with wads of fluff that imply that they are not willing to stand behind what they are saying.”
The UBS analysts do just that. After predicting that Nifty will touch 9600 points by end 2015. They go on to write “If our expectations of the earnings growth recovery are not met (with only 10-12% growth in corporate earnings)…the Nifty could decline to the 7,500 levels.”
So much for being in the business of making predictions.

The article originally appeared on www.FirstBiz.com on Nov 15, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

Goldman Sachs' Nifty target of 7600 needs to be taken with a pinch of salt

 goldman sachsVivek Kaul  
The investment bank Goldman Sachs is at it again. In a report dated March 14, 2014, the bank said that it expects the Nifty index to touch 7600 points during 2014. As I write this (on March 19, 2014, around noon) the Nifty is at around 6526 points.
This means that the Nifty needs to rally by around 16.5% from its current level to touch 7600 points. And if the Sensex rallies by similar levels it will cross 25,000 points during the course of the year.
Goldman Sachs offered a spate of reasons justifying the target of 7600 points for the Nifty (You can read them here). The only trouble here is that similar predictions made by Goldman Sachs in the past have gone majorly wrong.
Blogger and analyst Deepak Shenoy writes about these predictions in a post on his blog www.capitalmind.in. In November 2012, Goldman Sachs predicted that India will grow by 6.5% during 2013. The actual growth came in at less than 5%.
In March 2012, the investment bank predicted that by March 2013, Nifty would touch 6100 points. As on March 28, 2013, the Nifty was way lower at 5682.55 points. In August 2011, the investment bank predicted that by September 2012, the Nifty would touch 6600 points. As on September 28, 2012, the Nifty was at 5730.3 points. It only got anywhere near 6600 points very recently.
So that is how the past predictions of Goldman Sachs have gone. Hence, why take this new prediction seriously?
In fact, truth be told, Goldman Sachs is not the only financial firm making such predictions. They come by the dozen. Here are a few such predictions that were made at the beginning of this year. CLSA has predicted that the Sensex will touch 23,500 points by December 2014. Deutsche Bank Markets Research did better than CLSA and predicted that Sensex will touch 24,000 points by the end of this year. And Goldman Sachs in an earlier report dated November 5, 2013, had predicted that the Nifty would touch 6900 points by the end of 2014. This target has now been upped to 7600 points.
The economist John Kenneth Galbraith termed the entire business of prediction as a fraud. As he writes inThe Economics of Innocent Fraud “The fraud begins with a controlling fact, inescapably evident but universally ignored. It is that the future of economic performance of the economy, the passage from good times to recession or depression and back, cannot be foretold. There are more ample predictions but no firm knowledge.”
And why is that? “There is the variable effect of exports, imports, capital movements and corporate, public and government reaction thereto. Thus the all-too-evident-fact: The combined result of the unknown cannot be known,” writes Galbraith.
Given this, why are such predictions made? For one, making such predictions is a fairly lucrative career option. Also, investors (like most other people) want to know in which direction are the markets headed. In the recent past, there have been a spate of reports which essentially have been telling us that markets will continue to go up, because Narendra Modi will be the next prime minister of India.
The stock market investors are largely supporters of Modi, and any report that links Modi and the stock market going up is music to their ears. Sometime back an Indian stock brokerage predicted that Narendra Modi is likely to win the next elections and even made projections on how many seats the Bhartiya Janata Party is likely to win. This after some of its analysts had travelled six hundred kilometres through fifteen districts.
In a country where the most detailed polls go wrong, how can anyone in their right mind make a prediction on the number of seats a party is likely to win, after travelling through just 15 districts? The report was immediately lapped up by the pink papers and their readers, given that Narendra Modi winning the elections is music to their ears. As Galbraith puts it “The men and women so engaged believe and are believed by others to have knowledge of the unknown; research is thought to create such knowledge. Because what is predicted is what others wish to hear and what they wish to profit or have some return from, hope or need covers reality.”
Also, financial firms need a story to sell stocks to their clients. As the old saying goes, every bull market has a theory behind it. Andy Kessler, who used to be analyst with Morgan Stanley, recalls his experience in Wall Street Meat. As he writes “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.”
Predicting which way the stock market is headed is also a part of this game. Also, revising targets is an important part of this game. As Kessler writes “For some reason, Morgan Stanley was into price targets. I hated them. To me, they were pure marketing fluff. I would recommend Intel at, say $25. The first question I would get is what is my price target. My answer would be $40 for no particularly good reason. It was high enough to interest investors, but I was guaranteed to be wrong. If it hit $38, it was a great call, but I was wrong. If it went to $60, it was an even better call, but I was still wrong. What usually happened was that if the stock hit $35, I was asked to adjust my price target to $50, so that sales force would have a call to go out with.”
Let’s understand this in the context of Goldman Sachs’ Nifty target of 7600. In November 2013, the firm predicted that Nifty would touch 6900 by the end of 2014. Three months into the year the Nifty has already crossed 6500 points and hence, a target of 6900 points doesn’t sound ‘sexy’ enough. The solution, of course, is a new target which is at a much higher 7600 points.
What this also does is that it gives the financial firm a lot of coverage in the media. Every pink paper in the country, along with almost all business news websites have carried the news about Goldman Sachs’ new Nifty target. So, in a way it’s free advertising for Goldman Sachs.
Interestingly, when the stock market hit an all time high in January 2008, a stock brokerage which was looking to go public, released a report saying that the Sensex will touch 25,000 points before the end of the year. The report was covered comprehensively through the day across all business news channels. The next day the pink papers also splashed the news big time. So, the stock brokerage got the publicity that it needed. Of course, the Sensex still hasn’t touched 25,000 points, more than six years later.
This is not to say that the Sensex will not cross 25,000 by the end of the year or the Nifty will not touch 7600 points, as predicted by Goldman Sachs. For you all we know that might turn out to be the case. And the analysts at Goldman will then be termed as visionary. But when it comes to markets, it is always worth remembering what John Maynard Keynes, the great man that he was, once said: “Markets can remain irrational longer than you can remain solvent.”  
The article originally appeared on www.FirstBiz.com on March 19, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Why investors behave like football goalkeepers and how that hurts

goalkeeperVivek Kaul  
A very good friend of mine recently decided to take a sabbatical. But two weeks into it he started getting fidgety. The prospect of not doing anything was turning out to be too hot to handle for him. So, one morning he called up his boss and told him that this decision to go on a sabbatical was not the right one, and given this, he wanted to get back to work.
My friend’s boss, had taken a sabbatical last year, and understood the value of a big break away from work. Given this, he refused to let my friend get back to work so soon, and suggested that he continue with the sabbatical, now that he had decided to take one.
One more week into the sabbatical, my friend simply couldn’t handle it. One day he simply landed up at work, without consulting his boss. And thus ended his sabbatical.
The point in sharing this story is that it is difficult “do nothing”, even though at times it might be the most important thing to do.
In a recent interview to Wisden, the former Australian cricketer Dean Jones, pointed out that two thirds of Sachin Tendulkar’s game was based around forward defence, back-foot defence and leaving the ball, without trying to play it. As Amay Hattangadi and Swanand Kelkar write in a research eport titled The Value of Doing Nothing and dated February 2014 “As any coach would vouch, letting the ball go is possibly as important as hitting good shots in the career of a batsman.”
In fact, not doing anything is a very important part of successful investing. But the investment industry is not structured liked that. They have to ensure that their customers keep trading, even if it is detrimental for the them. As Arthur Levitt, a former Chairman of the Securities Exchange Commission, the stock market regulator in the United States, writes in Take on the Street – How to Fight for Your Financial Future “Brokers may seem like clever financial experts, but they are first and foremost salespeople. Many brokers are paid a commission, or a service fee, on every transaction in accounts they manage. They want you to buy stocks you don’t own and sell the ones you do., because that’s how they make money for themselves and their firms. They earn commissions even when you lose money.”
The brokers only make money when investors keep buying and selling through them. This is also true about insurance and mutual fund agents, who make bigger commissions at the time investors invest and then lower commissions as the investors stay invested.
As Adam Smith (not the famous economist) writes in The Money Game “They could put you in some stock that would go up ten times, but then they would starve to death. They only get commissions when you buy and sell. So they keep you moving.”
Levitt proves this point by taking the example of Warren Buffett to make his point. “Warren Buffett, the chairman and CEO of Berkshire Hathaway Inc and one of the smartest investors I’ve ever met, knows all about broker conflicts. He likes to point that any broker who recommended buying and holding Berkshire Hathaway stock from 1965 to now would have made his clients fabulously wealthy. A single share of Berkshire Hathaway purchased for $12 in 1965 would be worth $71,000 as of April 2002. But, any broker who did that would have starved to death.”
Hence, it is important for stock brokers, insurance and mutual fund agents to get their investors to keep moving from one investment to another.
But how do stock brokers manage to do this all the time? Andy Kessler has an excellent explanation for this in Wall Street Meat. As he writes “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.”
But why are these analysts taken seriously more often than not? As John Kenneth Galbraith writes in The Economics of Innocent Fraud “ And there is no easy denial of an expert’s foresight. Past accidental success and an ample display of charts, equations and self-confidence depth of perception. Thus the fraud. Correction awaits.”
This has led to a situation where investors are buying and selling all the time. As Hattangadi and Kelkar point out “In fact, the median holding period of the top 100 stocks by market capitalisation in the U.S. has shrunk to a third from about 600 days to 200 days over the last two decades.” Now contrast this data point with the fact that almost any and every stock market expert likes to tell us that stocks are for the long term.
This also happens because an inherent action bias is built into human beings. An interesting example of this phenomenon comes from football. “In an interesting research paper, Michael Bar-Eli2 et al analysed 286 penalty kicks in top soccer leagues and championships worldwide. In a penalty kick, the ball takes approximately 0.2 seconds to reach the goal leaving no time for the goalkeeper to clearly see the direction the ball is kicked. He has to decide whether to jump to one of the sides or to stay in the centre at about the same time as the kicker chooses where to direct the ball. About 80% of penalty kicks resulted in a goal being scored, which emphasises the importance a penalty kick has to determine the outcome of a game. Interestingly, the data revealed that the optimal strategy for the goalkeeper is to stay in the centre of the goal. However, almost always they jumped left or right,” write Hattangadi and Kelkar.
Albert Edwards of Societe Generale discusses this example in greater detail. As he writes “When a goalkeeper tries to save a penalty, he almost invariably dives either to the right or the left. He will stay in the centre only 6.3% of the time. However, the penalty taker is just as likely (28.7% of the time) to blast the ball straight in front of him as to hit it to the right or left. Thus goalkeepers, to play the percentages, should stay where they are about a third of the time. They would make more saves.”
But the goalkeeper doesn’t do that. And there is a good reason for it. As Hattangadi and Kelkar write “ The goalkeepers choose action (jumping to one of the sides) rather than inaction (staying in the centre). If the goalkeeper stays in the centre and a goal is scored, it looks as if he did not do anything to stop the ball. The goalkeeper clearly feels lesser regret, and risk to his career, if he jumps on either side, even though it may result in a goal being scored.”
Investors also behave like football goalkeepers and that hurts them.
The article originally appeared on www.firstbiz.com on February 8, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)