Wednesday, July 15, 2015

Are You A Rational Investor

When you were asked: “Are you a rational investor?” You would probably answer: “Well, yes! I guess. At least I THINK I am rational when making investment decisions.” Not according to Bayes’ Theorem. The definition for rationality according to Bayes’ rule is:  Logical thinking should involve probabilities, hypothesis and statistics to one’s belief. In other words, one should use statistical evidence to quantify his or her belief.

In the classical financial market efficiency theory, it is assumed that investors are rational with perfect information. Rational investors make decisions or judgement using reasoned thinking, based on facts, applying rules. However, in the real world, those described above do exist, but only for the minority. The majority of the market participants are irrational, at least according to the Bayes’ rule. If you look around people around you, you would notice that when faced with investment decisions, they prefer to listen to rumours and tips, rather than spending time doing the research themselves.

This ‘misbehave’ of humankind is actually discovered by the Nobel Prize winner, Professor Kahneman, who started the Behavioural Finance theory with Tversky in the late 70’s.  When conducting statistical research with a group of professional statisticians, they discovered that these experienced statisticians do not apply rules, but their own intuitions when it comes to simple problems given to them.

Likewise, when we need to make investment decisions, we may encounter some mental biases that prevent us from thinking rationally. In the following section, we shall discuss what are those and how we can overcome them.


This is the most documented of all psychological errors that people tend to be overly optimistic. Most people do not see the need to improve the way they make decisions, as they believe that they are already making excellent decisions. The unwarranted belief that we are correct is a major real-life barrier to critical thinking. Overconfidence often results in investors being fooled by small gains in a few trades, feeling much more in control of a situation than they are. Money managers, advisors and investors are consistently overconfident in their ability to outperform the market, but fail to do so.

Example: After a few small gains, investor A decided to invest a bigger sum on a particular stock. In the end, the stock encountered a major bad news that caused its stock price to plunge. Investor A has over-estimated his knowledge, and under estimated the risk involved by putting all the eggs in one basket. 

Remedy:  At the event of assessing an investment, it is crucial to assess the risk involved. Try to think for the worse case scenario, what is your contingency plan should it happens. Practice diversification of portfolios.

Herd Mentality

The phenomemon of the herd mentality can be useful in many ways. For example, researh shows that although 5% of the animals in a herd know the location of the water source, the entire herd is able to find it. In our dsily lives, we use this instinct to navigate the exit in the cinemas and crowded streets.We have to admit that herding is our human instinct. Herding always make us feel comfortable, and being the odd one out make us feel uneasy. We are programmed to to feel that the consensus view must be the correct one, and this mistaken belief has led to many distastrous decisions.

Example: During the 2000 dotcom bubble, despite the mean price earning ratio for the US technology companies is 156, investors still think the valuation of those dotcom stocks were "reasonable". They believed the majority was correct but infact it was not.

Remedy: It is not wrong to go with the trend. In fact, for trading, it is always good to trade with trends. However, we must know when to follow and when not to follow. To overcome this, we need to have an open mind, be able to see things in different perspectives. When investing, it is always good to ask for different opinions and to gather information form different perspectives. In view of other perspectives, we must be firm to our own beliefs, because when it comes to investing, there is no absolute right or wrong. As long as we focus on the fundamentals, we will be able to resist herd mentality.

Confirmation Bias

Confirmation bias is very common in us. We always have the tendency to select and filter information that fit into our beliefs. We ignore information or news that go against our beliefs.

Example: Miss A was choosing which stock to invest, Malayan Bank or Public Bank. After much consideration, she decided to buy Malayan Bank. After she bought the stock, she read an analyst report that Public Bank was better than Malayan Bank in terms of valuation, Miss A felt discomfort in her mind because this report was against her belief. In order to relief the discomfort, she would tend to disregard the news and went all the way to seek out information that confirms her belief. 

Remedy: Confirmation bias is a kind of "self- deception". To overcome this, we must constantly remind ourselves that when facing problems, we must seek out information from different perspectives. If necessarary, we must be willing to reassess our portfolio accordingly to the new information.

Intuitively, a "rational" or "unbiased" answer will include the consensus of the majority of the population. What is perceived as rational in one person may be considered irrational in another person, just like people from an African tribe wearing leater shoes is seen as "crazy", whereas it is perfectly normal to the rest of the world. A 90% survival rate for breast cancer in the developed countries is considered as normal but become unrealistic in the developing countries. Hence, we must learn how to see things in different angles to make more rational and unbiased decisions. 


Monday, June 22, 2015

Decoding The Stock Market

The financial markets are always full of uncertainties. It is generally believed that no one in the world can consistently beat the market as the financial markets are made up of market participants that "move" in groups. The markets only shift the momentum from one direction to the other when the group decides. Not when the individual trader believes the reversal should occur. 

It is believed that for any big movement in price, there must be a fundamental news associated with it, however, the extent of the price swing really depends on how the group think at that moment of the event. In this article, some historical events are highlighted, and we shall look at how the market reacted to each event. 

Date/ Events
Duration (Beginning of the crisis date to the lowest point)
Change in Index(%
2001  Sept 11
The US Twin Towers Terrorist Attack
S&P 500
2 weeks
9 weeks
2 weeks
2003  Feb 24

3 weeks
3 weeks
2004  Dec 26
Indonesia Tsunami

No effect
No effect
No effect
2005 Aug 28
US Katrina Hurricane

S&P 500
No effect
No effect
No effect
2011 Mar 11
Japan Earthquake/Tsunami

S&P 500
4 trading days
1 trading day
5 trading days
2011 Aug 1
US Debt Ceiling (1)

S&P 500
8 weeks
8 weeks
8 weeks
2013 Jan 1
US Debt Ceiling (2)
S&P 500
No effect
5 weeks
2 weeks

Markets are move by news, whether it is micro or macro news. Some news are unheard of such as "Black Swan" incidents, others like asset bubbles kept repeating in the markets. Examples of the historical asset bubbles are: the Japanese asset bubble in the early 1990's; the dot com bubble in the US in 2000; and the 2008 US subprime martgage crisis. These asset bubbles generally impact the financial markets more severely than those ad hoc Black Swan events. For examples: the Nikkei 225 hit 39,000 points before the crash, and until today the index can not be restored. While the US dot com bubble took the Nasdaq 15 years to recover to its 5000 level mark.

In the above table, it is shown that natural disasters and some ad hoc events have short term impact on the financial markets in US, Malaysia and Singapore as compared to historical asset bubbles (which is not included in the table). In addition, the incidents related to the US impacted the Malaysia and Singapore markets more than other Asian countires' event. We saw the local market reacted more on the US debt ceiling and the terrorist attack incidents. 

Another finding from the above table is that: the market will analyse the relavance of the event to our own country. For example, the United States is Malaysia important trading partner, hence, major incidents from the US will impact the local stock market negatively. The extent of the negative sentiments could last for 2 to 9 weeks and the index fell not more than 15% for the KLCI. 

How about our own local disastrous news? How would that affect our stock market?

In March 2014, MAS encountered a fatal commercial air accident that climed hundreds of casualties. At the event, the MAS shares plummeted. Several months later, in July, another MAS aircraft crashed which claimed more lives, but the MAS shares did not experience the same kind of decline. This shows that when things happened twice, it will not cause much havoc in stock market as people already had the experience, just as the US debt ceiling crisis.

How about oil prices? Yes, Malaysia is affected by the plunging of crude oil prices as we are a net exporter of crude oil. When the crude oil price crashed in September 2014, followed by ringgit depreciation, this is no more an ad hoc incident, but more of a fundamental impact to our economy. However, whether our economy can ride through these hurdles depends on 3 things: the interest rates, the housing prices and the liquidity in the financial systems. Since we know that market moves in groups, and investors confidence will greatly affect the sentiments of the market. In order to restore the market  confidence, we must first take care of the "feelings" of investors/ market participants. In general, I believe investors want to see low interest rates, stable housing prices, and healthy liquidity in our financial system. 

Wednesday, March 4, 2015

GST - An Economics Perspective

Recently I did a sharing on the current hot topic GST (Goods and Services Tax) with a group of pre-University students. I presented my view from 3 perspectives namely: the Government, Consumers and the Producers. It was an interesting discovering for the students and I hope to share with my readers.

GST? Didn't we had it before?
The first confusion that the general public has is that the term GST is not something new to us, we have seen it on our bills when visiting restaurants and paying legal fees. The current GST stands for "Government Services Tax", which is applicable in the service industry and its chargeable to the final consumers. Starting April 1st, it will be replaced by the Goods and Services tax which is charged on every single stage of the provision of goods and services throughout the distribution chain. Under the new system, GST will be charged from the raw materials to the wholeseller,  wholeseller to the retailer, and retailer to the customers. However, as long as you are not the final consumers, meaning you are the business owners, you may claim back your GST on most goods and services. Hence "Government Service Tax" is charged to the final consumers, while the new GST is charged at every stage of provision of goods and services.

Do consumers bear all the tax?
This is an interesting question. From the media and most internet articles we were told that the GST is a consumption tax and its a tax on the consumers alone, and that the producers (business owners) are the middle men, they collect the GST from the customers and later pass on the tax revenue to the government. However from the economics perspective, this is not true.

From the diagram above, we can see that the imposition of a GST will ultimately increase the price while the economic transactions (or output) will reduce. The blue coloured rectangle represents the tax revenue collected by the government. However this tax revenue is not borne by the consumers alone, it is infact shared by both the producers and consumers. The exact tax burden borne is actually depends on the "elasticities" of demand and supply for the goods and services which is another story that I will not cover here.

How would the producers bear the tax, isn't it tax on the spending?
Precisely! Tax on spending! Whether you are a producer or consumer, you are taxed on the GST. The only difference is that producers can claim back their GST paid if they are a GST registered company.  However, some small items like furnitures or A4 papers are not claimable. Hence, cost of doing business will increase ultimately.

Inaddition, there is the "Compliance Cost" that most business owners have to face. Depending on your company's turnover, some may need to submit GST to the authority every month! To cater for this change, companies need to install special softwares and they may even hire more staffs to work on this compliance. Hence, this accounting burden is on the wholesellers and the retailers in general.

Does the economy as a whole benefit from GST?
From the above diagram, the red triangle represent "Deadweight Loss" (DWL) which means there is a loss in economic welfare due to the imposition of the GST or any indirect taxes such as sales tax, import tax and excise duty. This loss in welfare is translated into inefficient allocation of resources and the loss of consumers and producers surplus (benefits).

Is GST progressive or regressive?
Many people say that GST is good because it is progrogressive, meaning the rich pay more taxes, the poor pay less. However, as a percentage of income, this may not be true. Although the high net worth people pay more GST because they can afford more luxury goods, however, their spending on GST accounts only a small fraction of their household income. Whereas the lower income group spend more on GST as a percentage of their income. Hence it is regressive in nature!

If it is bad, why 160 countries in the world impose GST?
The biggest benefit is that it is a good source of revenue for the government. In some EU countries, GST revenue account for 15% - 30% of the total tax revenue. This will definitely elleviate our budget deficit problem. In the past, as an oil producing country, our Petroleum Income Tax revenue accounts for 14% - 30% of our federal tax revenue. Given that the oil price has plunged dramatically, it is the right time to implement the GST to elleviate the burden from the government.

In addition, with the imposition of GST, it is believed we can recover some tax revenue from the "black economy", economic activities that were under-declared previously.

Hence, from the macro level, the imposition of a GST will benefit the whole country because it is definitely a good source of revenue for the government, it can reduce our budget deficit and hopefully with the extra tax revenue, the people can benefit from it, be it in the form of better infrastructures, healthcare systems or educatuon systems.

On the micro level, business owners and consumers are likely to suffer in the short term to medium term as this is a sudden cost to the business community, they will experience a squeez in their profit margin, this will take some time for them to adjust, maybe one to three years time. As for the consumers, the lower income group will feel the pain more as the tax is unavoidable and it will increase their cost of living.

Tuesday, January 6, 2015

Financial Planning Q&A Part 2


Miss A is 30 years old with an annual income of RM40000. She has been in the work force for 5 years now, and she would like to buy a house for herself. Can she afford a house in KL?


In Malaysia, most house purchasing is through financing from banks. Hence, whether Miss A can afford a house depends on whether she can obtain a mortgage loan from the bank. In general, there are various ways for the banks to approve a mortgage loan, one way is the 1/3 rule, which is RM4000/3 to get the monthly affordable instalment of RM1300 for Miss A. 

Based on the table below, if Miss A’s monthly affordable instalment is RM1000, she can afford a RM220000 house. In KL, with rising house prices, Miss A can only afford a house in the subsales market in the suburban region. 


Like most women, Miss B is a shopaholic. She is 26 years old and she love to shop online. She knew clearly the culprit was her credit cards but she could not control herself and she was in great debt. Suggest ways to help her to change from a shopaholic to a savvy investor.


Online shopping indeed brings us convenience, however if we abuse it, it may bring us disasters! Miss B’s problem is twofold. First, she is addicted to shopping; Secondly, she has the wrong attitude towards credit cards.

It is widely believed that addicted to shopping is a form of behavioural problem. The victims believe shopping may bring them happiness, at the same time releases their stress and other problems. However, psychologists think otherwise. The doctors claimed that happiness derived from compulsive shopping can only be short-lived, it does not solve problems at all. A better way is to go out, engage in meaningful activities with friends, work place or even charitable organisations. This way, Miss B will shift her focus onto other people instead of “herself”, and the satisfaction derived from doing charity work is more meaningful.

Next, Miss B should learn how to control her compulsive buying behaviour by drafting a purchase list every time before she buys. This way she is able to differentiate clearly which items are the “needs” and which are the “wants”.  In addition, she should record all her expenses so that she can keep track of her own spending.

Finally, Miss B should understand that credit card is a tool for “payment”, not for “financing”. For a start, she should use cash to make payment instead of credit cards to control her purchases. With all these measures in place, I’m sure Miss B would transform herself from a shopaholic to a money savvy queen.

Friday, January 2, 2015

Financial Planning Q&A Part 1

Recently I was interviewed by a local Chinese women magazine - Citta Bella (January 2015 issue), and I thought I should translate the script into English to benefit more readers.

There are various investment products such as unit trust, bonds, equities, real estates, gold, and forex that are available to us, which type of investment is most suitable for lady beginners? What are the basic rules and myths that we need to pay attention to?

To rank the risk level for the above investment products from low to high are: debt securities, real estates,  unit trust, equities, gold, and forex. The lower risk instruments such as bonds and real estates may require huge capital of investment, while higher risk forex requires smaller capital as forex is traded on margin. Does that mean beginners with small capital are forced to invest in those higher risk forex, futures and penny stocks? Not really!

I would recommend the greenhorn ladies to go for unit trusts, blue chip stocks and physical gold investment.

Firstly, let me talk about the unit trusts. There are a wide variety of them with different investment themes, the most common ones are the local equities funds that invest mostly in the Malaysian equity market. Since 1999, the Malaysian equity market has been performing steadily compared to the regional markets. There are also some unit trusts that invested in government bonds and corporate bonds with annual returns close to the fixed deposit (FD) rate, so I wouldn’t suggest you to invest too much into these funds, just put your money in the FD, as there is not much difference. 

Alternatively, there are unit trusts that invest in foreign equity markets, these funds are more risky. Although the potential returns may be high but I would suggest not more than 30% of your portfolio into this type of unit trust.

Next, let’s talk about stocks! I would like to emphasize that not everyone is suitable for the stock investing. I have seen too many bad cases, for example, many beginners when first entering into the stock market, they would think that they are the Warren Buffett type – value investor. They would choose some blue chip stocks for a start, hoping to win big money! 

Usually the biggest mistake is their attitude! They always wish that the stocks would appreciate within the short term, but in reality, unless we are in a strong bull run, otherwise these blue chip stocks hardly move, sometimes they may drop in prices. These inexperience greenhorns get panic and they would sell off these good value stocks, in returns, they would listen to rumours and bought into “penny” stocks. Hence, they lose even more in the end, and they ended up paying heavy price for that!

Finally, let’s talk about the gold and forex. I would suggest to the beginners not to invest in forex as it is high risk and prices fluctuate a lot, you may end up having sleepless nights!  However, I do recommend gold investment, especially gold jewellery for the ladies! Last year I did mentioned gold price was volatile and it’s price has fallen quite a bit, this year, I believe the gold price may fall to a bottom this year, and that it would be a buying opportunity for those gold bugs again! Start buying gold in the 2nd half of 2015 or whenever you see a substantial fall in the gold price.

Saturday, December 6, 2014

Commodities Cycles

The followings are some slides that I presented to my graduates beginning of this year on January 25th.

Note that the above analysis are based on probablity not 100% guranteed. It is my way of telling readers that commodities go through cycles, just as any other financial assets. If we pay close attention to the historical charts, we can get insights from them.

Finally, one small note on the palm oil prices, although I believe the palm oil price may bottom out in September 2014, however, March 2015 there might be a test of this year's low. If you are thinking of accummulating more on plantation stocks, perhaps you might want to spread out the investment thtoughout 2015.

Saturday, October 11, 2014

A Market Correction or A Bear Market

The stock markets around the world have the biggest selloff since January this year. Many are wondering if this is just a normal correction or the beginning of a bear market. I would like to share with you some of my thoughts.

From the fundamental perspective, in order to initiate a bear market we need to see a “crisis”, it could be a financial crisis, political crisis, epidemic crisis or catastrophic crisis. On top of that, the most important factor is the investors’ sentiments towards the crisis. For example, we have the Ebola, the middle east political unrest and the European debt problems now, whether we view these problems seriously or shrugged off the news depends on our experiences towards these news. If we had similar experience towards certain news, we would probably react bearishly for a shorter period of time than news that are something new for us. Sometimes small news may trigger big reactions from market participants. I had some study on the effect of moon and the psychology of investors, and statistics did show that investors’ sentiments are easily influenced by the faces of moon and the eclipse of moon. If you are aware that we just had a lunar eclipse on October 8th and the stock market reacted bearishly around this date.  In some cases, if the selloff is severe, it may violate important trendlines and once the damaged is done, it is difficult to recover within short period of time.

From the technical perspective, it is “normal” to see a correction in stock prices once in every three month or so. This is due to profit taking when prices moved higher. In addition, in every few years we shall see some bear markets that last for months. In this article, I would like to share with you some simple statistics on a “market correction” and a “bear market”.

Market Correction
A market correction occurs every 2-4 months, and it usually lasts 2-8 weeks, prices may fall from 5%-15%. For KLCI, we hardly had any price correction that is more than 5% this year except in January, the correction lasted for 6 weeks,  and now our KLCI is quite close to the 5% correction.

Bear Market
While a market correction is considered “short term”, bear markets can be “medium term” or “long term”. Medium term bear market lasts for months, long term bear market last for years. The price fall is more drastic, we may see prices fall from 15%-60%. Although by definition, prices drop more than 20% is considered officially a bear market, but I do see 15% price fall that lasts for 6 months which is considered a medium term bear market. (e.g, the US debt crisis, KLCI 2011 Aug – 2012 Jan bear market).

Possible scenarios
I do not wish to speculate if this is a bear market, let’s hope that it is a market correction.
If we believe that we are now having a market correction, we shall see 2 -  8 weeks of market correction started from September 12, and the prices are stated below:

S&P 500: price fall 5% - 15% which is 1920 – 1720.
STI: price fall 5% - 15% which is 3200 – 2868.
KLCI: price fall 5% - 15% which is 1795 – 1606.

Time target: We have past 4 weeks, next week is the 5th week, and by Nov 7th that’s the end of 8th week. 

The above are relevant for index as the statistics are based on the indices historical charts. The study of index chart is to give investors an overall sentiment of the market.