The Indian capital markets have been quite immune to any such frenzy effects for pretty long. Since the dramatic entry of the novel coronavirus, we have been witnessing the market indices nosediving, the stocks trading all deep in the red, hitting heavily on the investors. Bears have been running amok on the Dalal street giving little scope for the horny Bulls to recuperate. The novel coronavirus has tightened its grip in no time and has shaved off a sizeable pie of the market cap. The pandemic impact has triggered panic across the markets, shaken off the BSE-NSE barometers, putting the investors on a no-confidence mode. It is the first of its kind acid test for the Indian economy and the investing world remains critically perplexed. Investors are now in a perfectly hurry mode to draw down all the risks and to flatten the risk curve. They appear to have sensed the debacle…and the markets respond so freakily.
Though the coronavirus-hit has sent ripples across specific sectors and taken a toll on the demand-supply equilibrium, it is predominantly the ‘fear’ factor coupled with human biology at work, neuroscientists reveal. Rather than the erring fundamentals and technicals of the companies associated with, the pull down can more be attributed to the biological factors like psychological biases, genetics and neuroanatomy. Now, it is the speculative, and not the fundamental value of the stocks which plays the trick and determines the volatility. The investment community is too much predictive about the ramifications of the crisis and believes that the global economic equations will have a thorough revamp.
Many a times, we don’t act on facts as they really are, but rather as we perceive them to be. The neuroeconomic school of thought postulates the connect between the human nervous system and investment decision making. Our brain operates by forming shortcuts to manage and process such massive volumes of inputs it comes across every moment. Heuristics, as it is technically termed will become thinking patterns with repetition and may result in biased and irrational outputs. To this, our emotions – also contribute. It’s a psychological combo that at times has the potential to be a toxic formula for a major disaster.
Under optimal conditions, the controlled and automatic systems of the brain operate in harmony, but, stress, fed by emotions like fear, makes the impulsive brain to take over and demand immediate action. While the logical brain attempts to rationally analyse the options available and the potential consequences, the impulsive part short circuits our ability to critically think, by releasing the hormone, cortisol, into the cranial system. And when potential losses get bigger or consequences more extreme, risk perceptions intensify to feelings of fear; the assigned partners, the amygdala and the hippocampus get into action, program our memories of fear and anxiety and will ready us for a “fight or flight” response.
We are more likely to have vivid recall of negative experiences associated with our investments, than more neutral ones as when the markets may have been calmer. These vivid negative experiences can blot our view of the stock market during tumultuous times, and possibly make us more prone to panic selling.
Humans are also born with what is called as “the prediction-addiction.” Two areas of our brain, the nucleus accumbens and the anterior cingulate specialize in recognizing patterns and choosing between conflicting alternatives. All too often, that turns out to be wrong - but our brains are hardwired to project the past into the future; it’s a biological imperative. And if a repeating pattern is broken, as it is so often in the financial markets, then batches of neurons suddenly flare in the insula, caudate and putamen areas of the inner brain and generate feelings of fear and anxiety. The longer a pattern has previously repeated, the more violently the brain responds when the pattern is broken.
The effect of the hormone, dopamine explains why the market overreacts to any short-term disappointment. Once a gain becomes associated with a particular cue, the brain releases dopamine on that cue even before the gain occurs. But, something strange happens if that cue fails to materialize. Our brain flooded with dopamine on anticipation of the gain instantly dries up and pulls us to an extreme depressive state and this wrenching swing from euphoria to depression results in chaotic market trends.
While these evidently help explain how an individual investor could make a horrendous investment decision, how do we account for millions of other investors simultaneously doing the same thing? This can well be explained by the concepts of social behavioural science. Humans are social beings, and our behaviour can heavily be influenced by what others around us think and do. Individuals, through emotional contagion often converge by modelling behaviours and beliefs of the larger group within which they are embedded. People often explicitly attempt to infer others’ beliefs, attitudes or preferences; and draw on these to help determine their own perspective. When our thoughts start to become cluttered, under stress or being in an emotionally low state, we may seek out and succumb to the opinions of our society, consciously or subconsciously and such pressures may exert a greater influence over our decisions.
Herd mentality is the phenomenon which made the markets crash-land in the present pandemic crisis. The herd mind is in fact a retort to not having ample information and assuming that others around us can actually give us an alternative to the way decisions are made. In herding, de-individuation provides a mechanism for situational forces to collectively drive behaviour, immersing the individual into the group or herd. Financial literacy of the investor, investor confidence, access to information and demographic factors like age, experience etc., which are negatively correlated to the herding behaviour explain why most of the Indian investors are prone to herding bias.
The market is unlikely to behave rationally until the uncertainty is done away with. Stick on to your well-intentioned and well-constructed financial plans. In fact, capital markets are proven good for long-term investments. Hold On !! Be Logical !!
The world is definitely not nearing the end; at the maximum, it would just have a reboot which paves way for new economic leaders to emerge. A total shut down of the global economy, as is being widely perceived is far from reality and the present bio-annihilant unrest is too brief an event. The measures adopted by the government, and RBI, in special are welcome moves to boost investor confidence. We are on the right trajectory to bring the situations under control and back to normalcy at the earliest.
So, let’s wrap up the hearsays and wait for the future to unveil. As the saying goes – “Picture abhi baki hai”.
(The author is a wealth manager with the State Bank of India and a certified financial planner. He can be contacted at firstname.lastname@example.org)