Why we don't always rationally decide
in stock market

Share Shah

Quite often we choose the investment alternatives that provide us with psychological solace rather than the ones that offer them economic benefits. Some people might call these factors idiosyncrasies, anomalies or behavioural oddity. They also could aptly be described as simply human nature. Psychologists, philosophers and poets have always known that people have a tendency to be averse to risk. This helps explain why many people will reject a fair bet of tossing of a coin. From a straight economic perspective, people should be indifferent to betting on a toss of a coin since the odds of winning and losing are equal. The avoidance of risk among people is manifested also in their propensity to diversify their investment portfolios. Few stock investors feel comfortable investing all their assets in only one stock, even though it might offer them the opportunity to earn an extremely high return.
   The reason investors tend to be so lies in the weight they attach to gains and losses. Research has shown that people tend to weigh the prospect of losing more than they weigh the prospect of gaining. That is because people feel the pain of loss more than they do the pleasure of an equivalent gain. For example, if a Taka 100,000 investment returns 20 per cent, the investor receives more than just a Taka 20,000 gain. He also experiences a sense of pride. Conversely, if an investment loses 20 per cent, the investor loses more than Taka 20,000. He also experiences a feeling of remorse and loss of face. Since remorse is felt more deeply than pride, people will tend to avoid situations in which the chances of each occurring are equal. Although the odds may be the same, the impact on the investor of each possible outcome is psychologically different.
   Another factor that affects investor's decision-making is the investor's particular frame of reference. Studies have shown that when asked to choose among two alternatives, people will reach opposite decisions based solely upon their frame of reference. The two most common investor frames of reference are situations in which the investor is currently losing money or currently recording gains.
   Research has shown that frame of reference is so important to the decision-making process that it can lead people to ignore the alternative that is most financially beneficial to them and choose the alternative with a lower payoff. Even the decisions of professional investment experts are affected by their current frame of reference. When some are underperforming their colleagues through the year; studies have found that they will take greater risks in order to catch up. Research has shown that people tend to become more averse to risk when they are facing the prospect of a gain and more risk seeking when they are facing the prospect of a loss. Similar behaviour has been observed amongst card players. The late Rollo May once said, "It is an ironic habit of human beings to run faster when we have lost our way."
   If such an irrational behaviour takes over a group or a crowd, like the illegal street market of 1996 than all hell can break loose. It would be a start of a financial mania, like any aberrant and self-destructive group activity, further growing as new entrants come and in time legitimising its activity.
   A French sociologist, Le Bon has demonstrated this dynamics of human behaviour, and concluded that in a crowd, individuals take the inaction or action of others as a cue that this is the right course. Freud later emphasized crowd's irresponsible behaviour based on collective hallucination and intellectual inferiority. It is no revelation to apply this concept to group dynamics in financial manias, for as Charles MacKay observed in his book written in 1841- Extraordinary Popular Delusions and the Madness of Crowds, "Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."
   In such a situation, fundamentals will be soon forgotten and bubbles will start growing. A bubble is used to describe a stock that is trading at a price above its fundamental value. Typically, the fundamental value of a stock is equal to the present discounted value of the stream of dividends paid by the stock.
   Basically, it is the amount of money that you can expect to get back from the stock if you hold it into the distant future- taking into account the fact that present money is worth more today than tomorrow. Things like a healthy economy, growing profit margins, etc. lead to better fundamentals and a higher stock price. The best way to think about the fundamental value of a stock is to think of the value of the company as the price it would receive should it be sold at some point in time.
   So, why does a bubble's price stay above its fundamental value once it's there? This is because if there is a bubble that has some chance of "bursting" or have its price drop significantly, investors will not be willing to hold the stock unless there is a high rate of return. As the price rises, the loss of money due to a fall becomes even greater, causing the price to rise even faster. The price rise will continue to accelerate until the price falls back to its fundamental level.
   Why the price is initially too high is a big and strange question! It could simply arise from valuation mistakes, irrational expectations, animal mentality, or other idiosyncratic habits. A quickly rising price reflects either a legitimate increase in the future earnings of the company, or a stock bubble - in which case it cannot be told from current information. The fundamental price of a stock should depend only on the future performance of the company. We can only observe the price, but not the future - at least without a crystal ball. People are wrong about their bubble predictions all the time! Even after the fact, a large fall in the price could be either due to a bubble bursting, or due to bad news that reduced the estimates of future performance and lowered the fundamental price.
   A bubble can be perfectly rational in the sense that everyone is making reasonable decisions. The investors simply demand a higher rate of return on stocks that face a risk of bursting. Bubbles are not necessarily irrational. On the other side, a stock that follows an irrational behaviour may be priced exactly according to fundamentals e.g. perceived future dividends; but may be completely irrational in the sense that the perceptions are too high. In this case the prices are too high- not because of a bubble, but because of mistaken expectations of the future. Prudent investors should therefore not take only classic investment theories into account but also remain tuned to human behaviour which might offer a more palatable and profitable approach to investing.

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Dhaka's bold strides in
export-oriented shipbuilding

Shamsul Huda

Bangladesh has made impressive bold strides in export-oriented shipbuilding and has already exported a few large ocean going vessels. The present information technology-based competitive world market requires foresight, talents, updated entrepreneurship and competitiveness.
   Bangladesh's entrepreneurs in the field of building ships for export are now quite capable of competing with other shipbuilding nations by utilising the vast experience and the knowledge earned over the last century. A pool of talented workers, painters, fitters, welders and foreign-trained engineers are available in the country now. Thousands of local skilled workers are migrated to other shipbuilding countries as they pay them attractive salaries and provide much improved facilities, said Mostafa Kamal, managing director, Meghna Group. The company has recently entered export-oriented shipbuilding industry as it felt the real pulse of the sector in the international arena.
   
   A vessel a year
   Mostafa Kamal further said, "I have a plan to build a world-class shipyard in my country that will manufacture at least one ship every year", he said, who is also chairman of the group. "It is unbelievable that Bangladeshi entrepreneur can think like that, but it is real. I want to change the idea about our entrepreneurs and want to establish the fact that we are talented and can do any high-tech business in the world."
   "Our geographical location regarding ship export is unique. The draft of our river is high and ships can enter and exit from the rivers to the sea. Low cost of labour, efficiency of the workers, their knowledge in spoken English is better than that of workers from China, Vietnam, Korea and Japan. So, it is not difficult to train the Bangladeshi workers in building world-class ships," he said.
   Bangladesh's brave shipbuilders have already become experienced in building ships, cargo vessels, launch, steamers, ferry, pontoons, fishing boats and other small and medium-sized ships for domestic use.
   Moreover, Bangladesh University of Engineering and Technology (BUET) is producing graduate naval architects, Mercantile Marine Academy (MMA) is producing deck and engine room cadets who become merchant mariners that is captain and marine engineers. Bangladesh Institute of Marine technology (BIMT) is producing artificer that is draftsmen, shipwrights and diesel mechanics. Thus, quite a good number of engineering and higher level technical skills are available in marine fields in Bangladesh which can encourage the brave entrepreneurs to put money in building ships. Shipyards in European and in other rich countries are becoming costlier than in Asian countries as their building cost is becoming higher by the day.
   Some European countries are providing 50 per cent subsidy to the shipyards to benefit the entrepreneurs. In this regard, Bangladesh enjoys all opportunities of building ships. "Our skilled workers, engineers and semi-skilled workers are working in most of the Asian shipyards," Kamal said.
   If the government support is available, this sector can build high-tech ships. Within a decade this industry will exceed the earnings from RMG export. So, it is high time for the officials and policy makers to declare it as a thrust sector and provide facilities like formulation of comprehensive policy for shipbuilding.
   "At initial stage we do not need subsidy. What we need is only policy and other infrastructure supports", Kamal said adding that it is an industry using huge quantity of mild steel. Like the RMG sector, ship export sector also needs a back-to-back letter of credit support from the government.
   "Our own company has recently signed US$40 million agreement with a South Korean company named STX to build shipyard infrastructure. Shipyards require a large shed to work around the year. By the joint collaboration with STX we hope to build at least one ship every year", he said.
   Shipbuilding is both white and blue collar labour-based industry. So, it will employ a huge member of engineers, naval architects, marine engineers, carpenters, welders, painters, fitters and other related professionals. The industry is highly value added involving direct engineering cost, labour cost, cost of quality control, labour overhead, safety insurance and it accounts for 22-36 per cent value addition. Besides, if the locally made metals and other raw materials are used the value addition figure will increase substantially.
   "Though it's late, but we have enough time", Kamal said. Ananda has successfully exported its first manufactured vessel. With this milestone event, Bangladesh has achieved the status of a ship exporting country. Shipbuilding has shifted from Europe to Japan to Korea; and now it is shifting to China, India, Veitnam and in Bangladesh. So, if the government's full patronage is available, Bangladesh will also become one of the world's major shipbuilding nations, Kamal hopes.

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