Investor Behaviour — a case of Narratives and Biases

Sajid Khetani
Strategy Square with Sajid
5 min readJun 21, 2020

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The stock markets have bounced back and have shown a ‘V-shaped’ recovery and are trudging towards levels of Jan 2020. All this has happened within a span of a few months. How can people be so oblivious to things which are happening on the main street aka the real economy? On one hand, the economy is being crippled by lockdown and on the other hand, consumer confidence is at a record low. And the pandemic is showing no signs of slowing down and has now spread to almost all regions of the world, with no clear endgame in sight. So, what is really going on here?

In my opinion, there are three probable factors at play, which provides an anchor to understand the underlying investor behaviour.

Factor 1 | Democratizing Investments

Over the past decade, there have been considerable rise in investment platforms enabled by technology. From an Indian standpoint, we have Zerodha, one of the largest broking platform in India and from the US context, there is Robinhood. The key value proposition which these platforms have is the convenience of investing or trading on this platform, with zero commission/brokerage.

This has enabled a complete new breed of investors to include, young students and homemakers. In the traditional scenario, a stock broker played a critical role. Most of the orders (buy/sell) were placed through these intermediaries and only advanced investors used to trade on their own using the broking platforms. With these new age platforms, any investor can trade or invest without any inhibition. These have enabled the new investor segment to experiment and experience the markets first hand, albeit with small investment amounts.

Investing in markets requires a certain temperament, and lot of these new investors are in for the thrill which they derive from participating in the stock market. It is no different than people gambling in casinos or betting on games.

Factor 2 | Power of Narratives

Narratives play a big role in all spheres of life and the stock markets are no exceptions to that. One narrative which has been propagated over the years and with good intention is, “buying on the dip”.

I can recall the days of the 2008 financial crisis very clearly. The markets were literally melting in the month of Sep 2008, but by March 2009 the markets came back with a roar. The key factors which worked then were the coordinated efforts by the governments and central banks across the globe with the way of stimulus and bailout packages. That has become a dominant narrative of today as well — we were (are/will be) saved by our central banks. The stimulus was there then and it is the case even in this crisis.

Factor 3 | The Case of Irrational Exuberance

The phenomenon which we are experiencing at the moment is very common in the realm of stock markets and is known as “irrational exuberance”. The term was popularised by former US Fed chairman Alan Greenspan in a speech addressing the internet bubble in the stock market. It can be defined as:

An unfounded market optimism that lacks a real foundation of fundamental valuation, but instead rests on psychological factors.

In simple terms, when investors start believing that the rise in prices in the recent past predicts the future, they are acting as if there is certainty in the markets, causing a positive feedback loop of ever-higher prices. There is a complete disconnect from the ground reality and is the primary source of bubbles in asset prices across the board — be it stocks, real estate or even bitcoin.

Yes Bank — Testimony of Irrational Exuberance

Let’s look at the case of Yes Bank. The bank was under stress for a certain period of time, but it was only a few months back that RBI intervened. If you look at the retail investor participation in the stock, it had gone up from 8% in June 2018 to 48% by Dec 2019.

Source: Moneycontrol.com

On 21st August 2018, the stock price peaked at Rs.397 and in 5 weeks time, it crashed to Rs.183 and the slide continued at a steady pace. The retail investors kept on buying on dips, on the hope that they are getting a good bargain on their investments. There were good reasons to believe so. The bank was one of the leading private sector banks and had a good track record. When the RBI intervened early this year, the stock price crashed to a low of Rs.5 trapping a lot of retail investors and in the process destroying shareholder value.

Having said that, investor confidence is only one of many forces in the market. Stock prices, first and foremost are determined by supply and demand. These are in turn determined by fundamental factors such as the business environment, the company’s performance, macro economic factors, etc.

Below is a snapshot of the financials of Yes Bank over the past 2 years (half-yearly basis). Being a listed entity, the company has to declare their financials on a quarterly basis and this information is available in the public domain. There were enough red flags on display — rising Gross NPA a case in point.

Source: Moneycontrol.com

Investor Behaviour = Narratives + Biases

The Yes Bank case highlights how the power of narratives and investor biases play a role in investing decisions. At the end of the day, Investing is like philosophy. There are no right or wrong philosophies, it is the quest for achieving the desired results.

To sum up, what sets a great investor from a good investor?

It’s not really the search for “alpha” (above average returns), but making good (vs great) investments and behaving correctly.

Disclaimer: The intention of this article is to provide information. Nothing in this article has to be construed as advise or recommendation.

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Business & Behavioural Design Strategy | Expertise in Design Thinking, Consumer insights & Business Model Design | Founder at Le Monturé Strategy