Showing posts with label behavioral finance. Show all posts
Showing posts with label behavioral finance. Show all posts

Sunday, October 22, 2017

The BUY EVERYTHING Party Poopers: Zhou Xiaochuan, Gordon Brown, Wolfgang Schaeuble, Jean-Claude Trichet, Klaas Knot and Richard Thaler

Signs of historic times, indeed…

 
From Rappler: (October 20, 2017)

A Dutch family has sold virtually all they own, including a business, their home, two cars and a motorbike and invested the takings in bitcoin just as the virtual currency is soaring to new heights.

"We are putting everything into bitcoin, we've sold everything to invest in this currency," Didi Taihuttu told AFP.

The 39-year-old is currently living in a camping ground with his family, aiming "to put as much money as possible to one side and transform it into bitcoin."

Having turned his back on a "materialistic life" three months ago, Taihuttu and his wife and three daughters, aged 12, 10 and seven, are living in a small holiday chalet in a camping ground in eastern Venlo in Netherlands and are watching their savings "grow every minute somewhere on the cloud".

Bitcoin smashed through $6,100 last Saturday, reported the CNBC, for a thundering over 500% return year-to-date.

Bitcoin has just been part of the overall risk ON moment. (upper window)

A deck of charts, I previously posted here, depicted that it has been a BUYING EVERYTHING! “It's Market Mania for Assets All Around the World”!

Well, risk ON everything and everywhere has only been intensifying.

Spread differentials of sovereign and high yield (corporate and emerging market) bonds have compressed to unseen levels. (middle chart) European junk bonds have even attained lower yields than the 10-year US treasury! Junk bonds have now achieved risk-free status! The world has turned upside down! And given the compressed spreads, even junk bond fund managers have turned or shifted into owning equities! (bottom chart)

While everybody seems to be enjoying the free money orgasmic shindig, notable party poopers have emerged.

The People’s Bank of China governor Zhou Xiaochuan warned of the “Minsky moment” (collapse of asset prices).

From John Authers of the Financial Times: October 21, 2017

What exactly is the Chinese for “Minsky moment”? The chances are that we will soon need to know, after a startling moment of clarity from the outgoing chairman of the People’s Bank of China.

Speaking on the sidelines of the Communist party congress in Beijing, Zhou Xiaochuan, who is soon to stand down as governor of the PBoC, said: “If we are too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a ‘Minsky moment’. That’s what we should particularly defend against.”

This might sound unexceptional. But it is about as close as someone in Mr Zhou’s position can come to yelling “fire” in a crowded theatre. To quote Robert Hockett, an expert on China at Cornell Law School: “It’s calculated to inspire panic. It’s almost an incantation to panic — especially in China.”

Why rouse the Communist party congress to panic? Haven’t the Chinese government been successful in weeding out excess capacity in the property sector, such that ghost cities are now being filled or occupied?
 
It turns out that the Chinese government, through the local apparatchiks, has stealthily been bailing out developers and implicitly created a mass housing project.

From the Financial Tribune (October 15, 2017)

An attempt by the Chinese government to fill empty apartments is pushing indebted cities farther into debt. Over the past three years, more than 200 Chinese cities have been buying surplus apartments from developers and moving in families who live in neighboring villages or on condemned city blocks, a program it plans to continue through 2020, according to the Wall Street Journal. Local governments spent more than $100 billion in 2016 alone to either buy housing or subsidize purchases.

The central government is supporting this strategy through bank lending, and it has helped give the property market a boost, which makes up a third of China’s economic growth.

However, the strategy is undergirded by debt: cities borrow from state banks to pay for the subsidies and purchases, and they pay back the loans by selling more land to developers, who then build more housing and accumulate more debt, prompting another bailout from the state.

Local governments borrowed 972.5 billion yuan ($147.57 billion) last year from the government’s main housing lender, which was nine times higher than three years earlier. More than half of those loans went to housing purchases or subsidized buying, while the rest funded government-built houses.

First, the local government buys out inventories from developers. Then, they bus in people to have these occupied. Two birds in one stone!

So it is not economic growth but politics to camouflage excesses that have led to a cosmetic reduction of capacity. But as the article notes, there have been numerous ramifications.

One, both government and the private sector have only amassed more debt. Two, because developers were handed free money, they go and acquire new land for fresh inventory which led to sharply higher property prices. Three, which is tied to the second, property developers indulge in building more capacity. So excessesleads to even more excesses. These subsidies have only accumulated pricing and distributional distortions, which reveals the magnified extent of credit financed malinvestments.

China’s Total Social Financing has climbed by a whopping $2.9 trillion in 12 months EXCLUDING local government and other informal (shadow banking) debts! While bank debts have been exploding, China’s belly of the yield curve has inverted. Such inversion means that the bond market is expecting a sharp tightening of monetary conditions.

Wonder why Mr. Zhou sounded the alarm bells on the ‘Minsky Moment’? Could it be that the reason for Mr. Zhou’s retirement is because he intends to bail before the ‘Minsky Moment’ strikes?

Now to more party poopers… (all bold mine)

From ex-UK PM Gordon Brown (BBC September 28)

Former prime minister Gordon Brown has warned that the UK and other major economies are not well-equipped for the next financial crisis.

Mr Brown, who was in Number 10 during the banking crash of 2007-8, said they need to guard against "complacency" or "not being aware" of risks.

The next crisis could come from Asia's shadow banking sector, he suggested.

From former president of the ECB Jean-Claude Trichet (Nikkei Asia October 19)

Jean-Claude Trichet, former president of the European Central Bank, warned of ballooning global debt in a recent interview with the Nikkei, saying: "Be very careful. A new crisis can occur." The debt-to-GDP ratio, which has been rising primarily in emerging markets, is sending such signals, he said.

"I consider that an important indicator of economic and financial vulnerability, at the level of the global economy, would be the proportion between the overall outstanding global public and private debt as a proportion of the overall GDP," he said. The ratio increased as much as 25 percentage points between 2000 and 2007, from 250% to 275%. The jump was partly responsible for the global financial crisis. After the crisis, the figure is still rising, rather than falling, reaching 300% today.

From Germany’s Finance Minister Wolfgang Schaeuble (Business Insider October 9)

Germany's outgoing Finance Minister Wolfgang Schaeuble warned that spiralling levels of debt, as well as the growth of liquidity across the world, risk creating a new financial crisis…

"Economists all over the world are concerned about the increased risks arising from the accumulation of more and more liquidity and the growth of public and private debt. I myself am concerned about this, too," Schaeuble said.

The claim that “economist all over the world are concerned about risks” seems like a fallacy of composition. That’s because this definitely does not apply to the Philippines.

From ECB’s Governing Council member and Dutch Central Bank president Klaas Knot (Bloomberg, October 9)

Financial markets may be underpricing global risks, leaving them vulnerable to a major correction, according to European Central Bank Governing Council member Klaas Knot warned.

As global stocks surge, measures of volatility suggest unprecedented calm even as crises around the world -- including the Catalan separatists in Spain, Turkey’s diplomatic row with the U.S., North Korea’s missile tests and the danger of a hard Brexit -- make political headlines.

“It increasingly feels uncomfortable to have low volatility in the markets on the one hand while on the other hand there are risks in the global economy,” said Knot, who is also the president of the Dutch Central Bank.

Finally, recently awarded Nobel winner behavioral economist Richard Thaler (Bloomberg, October 10)

A buoyant and complacent stock market is worrying Richard H. Thaler, the University of Chicago professor who this week won the Nobel Prize in economics.

“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping,” Thaler said, speaking by phone on Bloomberg TV. “I admit to not understanding it.”

“I don’t know about you, but I’m nervous, and it seems like when investors are nervous, they’re prone to being spooked,” Thaler said, “Nothing seems to spook the market” and if the gains are based on tax-reform expectations, “surely investors should have lost confidence that that was going to happen.”

The economist said that he didn’t know “where anyone would get confidence” that tax reform is going to happen.

Funny but, the Nobel awardee just forgot behavioral basics: the herd mentality and the post hoc rationalization for tax reform.

Forget them noisy party spoilers, JUST PARTY ON!

Saturday, October 05, 2013

10 Most Common Biases affecting the Psychology of Investing

ConvergEx's Nick Colas has an interesting list of the “10 most common biases affecting the psychology of investing” (via the Zero Hedge)
1) Anchoring & Adjustment:  This combination occurs when initial information unduly influences decisions by shaping the view of subsequent information.  Once the “anchor” or initial information is set, there exists a bias for interpreting other information around the anchor.  Car salesmen frequently use this tactic when presenting an initial sales price, making the subsequent negotiated prices seem lower than the initial price even though they are still higher than what the vehicle is actually worth.

2) Attribution Asymmetry: The concept here involves people’s tendency to attribute success to internal characteristics (such as talent and innate abilities) and to attribute failures to external factors (like simple bad luck).  Research has shown the reverse to be true when evaluating the successes and failures of others.  The lesson here is most valuable when you hit a “hot streak.”  When you experience speed bumps, don’t be quick to write them off as poor luck – there could be a fundamental problem with your strategy.

3) Choice-Supportive Bias:  By distorting recollections of chosen courses of action versus the rejected courses of action, people tend to make the chosen outcomes seem more attractive that the foregone ones.  Just as people more frequently remember “good” memories than they do “neutral” or “bad” memories, the belief that “I chose this option therefore it must have be superior” can lead to a false recollection of the ultimate outcome.  Learn from your mistakes – don’t forget them.

4) Cognitive Inertia: This is just psychological speak for the unwillingness to change thought patterns in light of new circumstances.  Quite simply, do your homework and keep up on your investments.  If a company slashes guidance, for example, perhaps you should consider altering your investment accordingly.
5) Incremental Decision Making & Escalating Commitment:  These biases occur when people view a decision as a small step within a larger process, rather than as a singular choice.  As a result, this viewpoint perpetuates a series of similar decisions, when perhaps many of those decisions should be evaluated with a fresh mind.
6) Group Think: Grown-up lingo for peer pressure, group think occurs when one feels compelled to adhere to opinions held by a larger group.  This one’s easy – don’t let others sway your opinion.  Groups tend to form a singular opinion based on the opinion of the loudest or most influential person in the group.  Doesn’t mean he’s right.

7) Prospect Theory: This theory explains that people are more likely to take on risk when evaluating potential losses; though in looking at potential gains, humans have the tendency to be risk-averse.  In other words, losses feel worse than gains feel good.

8) Repetition Bias: The bias results from the willingness to believe what one has been told most often and by the greatest number of different sources.  Remember all the hoopla over Facebook’s IPO?  And then its year one performance?  Yeah, everybody though it was a hot stock and only now has it drifted above its IPO price.

9) Sunk-Cost Fallacy: If someone makes a decision about a current situation, based all or in part on what they have previously invested (money, time or otherwise) in the situation, they are suffering from sunk-cost fallacy.  Not matter how much you’re down on an investment, if it’s likely to never be recovered, then cut your losses and let it go.

10) Wishful Thinking: This “problem” happens when people are too optimistic; wanting to see things in a positive light can distort perception and objective thinking.  Just because you really really really want your investment to appreciate, doesn’t mean it will.  Investing should not be treated as gambling.
I would 10 more to this list

1.confirmation bias—search for information that confirms on embedded beliefs rather than objective analysis (related to selective perception)

2.endowment effect—ascribing more value on things or ideas that are owned or possessed (related to sunk-cost)

3.optimism bias—the tendency for people to believe that bad things will happen to everyone else but them (Nassim Taleb calls this the denigration of history)

4.regret theory—reaction to opportunity loss (I should have done this…)

5.status quo bias—preference for the status quo, rejection of change

6.clustering illusion—the tendency to see patterns where there is none or the intuition for pattern seeking

7.gambler’s fallacy--mistaken belief that if something happens more frequently than normal during some period, then it will happen less frequently in the future or (Nizkor) a departure from what occurs on average or in the long term will be corrected in the short term

9.hindsight bias the presumption of knowledge from something that has already occurred or the “knew-it-all-along effect”

10.survivorship bias—tendency to focus on winners while overlooking the others due to lack of visibility


Cognitive biases and heuristics signify as the "law of least effort"- the tendency to desire more rewards with lesser efforts or costs. 

As Nobel Prize psychologist and author Daniel Kahneman, wrote in Thinking, Fast and Slow (p.35) 
A general “law of least effort” applies to cognitive as well as physical exertion. The law asserts that if there are several ways of achieving the same goal, people will eventually gravitate to the least demanding course of action. In the economy of action, effort is a cost, and the acquisition of skill is driven by the balance of benefits and costs. Laziness is built deep into our nature.