By W.A. Wijewardena –

Dr. W.A. Wijewardena

The bull-run in the CSE

It was a happy migration from bears to bulls in the Colombo Stock Exchange or CSE in the post-war period beginning from mid-2009. The indices in the Stock Exchange, which remained in a stagnant position for many years, got a sudden boost after the end of the war.
The All Share Price Index or ASPI, which had fallen to the 1,503 level at the end of 2008 from 2,541 from 2007, rose by more than 100 per cent to 3,386 by end 2009, the increase occurring after the defeat of the LTTE in May, that year.

Then, the move was one way in 2010, raising the index by almost another 100 per cent to 6,636 by the end of the year.

During this period, it was bulls that had reigned in CSE. The bull reign came to a sudden stop in 2011 with the ASPI falling to the 6,074 level by the year-end. The bears that took over the reign of CSE in 2011 were equally active as their predecessors and they pretty soon brought down the ASPI by 22 per cent to the 4,700 level by June 2012.
The bears were rather active till end August, but with the transfer of power to a new team of regulators in the Securities and Exchange Commission or SEC in early September, their power was decimated within days. The bulls took the reign of CSE once again. Accordingly, by early October, the level of the ASPI at closer to 5,900 was just short of 175 units to beat the level it had at the end of 2011.

Has the bull-run refuted the doomsday preachers?

The new bulls that had invaded the market forcefully filled the market once again with hopes as it had filled it in mid 2009 when Sri Lanka won the terrorist war conclusively.
The writers on the new development in CSE were so jubilant that they very quickly penned that the rising trend in CSE was a refutation of those who had earlier predicted certain doom of the market when the top regulators were changed by authorities in an apparent political intervention in the market to their dislike.

What goes up should come down one day and vice versa

It is quite typical for any market to have bulls and bears alternating each other from time to time. This is because the markets, which follow the Laws of Nature, not laws of men in authority, have one fundamental trend-principle built into them. That is, what goes up will come down one day and, in its inverse, what comes down will go up similarly. Hence, bulls should be followed by bears and bears should be followed by bulls. There is nothing extraordinary about this cyclical change.

While the cycle completes its course naturally, the predictors may be right about the direction of the cycle but wrong about its duration. It may be longer or shorter than the duration they have predicted for the upward or downward cycle to complete its full course.
But one important principle underlying the cyclical changes in markets is that those who express jubilance when the market starts its up-cycle as well as those who predict doom when it starts its down-cycle are to face a big disappointment when the cycle’s next turn begins its journey quite opposed to their expectations.

The invisible gorilla in the market

But the problem in any market, or for that matter in any human experience, may come from a different source. That is the inability to detect the ‘invisible gorilla’ present around them and that oversight may sometimes become fatal to people.
The term ‘invisible gorilla’ was coined by psychologists who have done experiments about human attention problems. Though people believe that they have seen everything which they should see, they always fail to notice obvious things around them when their attention is focused on a specific matter or their vision is blinded by emotional build-ups.
Consider the story about Archimedes, the 3rd century BCE Greek scientist, running naked along the streets of Syracuse shouting ‘Eureka’ when he discovered that the volume of water spilt over the bath tub was equal to the volume of his body immersed in the water. Or consider as another example the teenage girl walking along the railway track speaking to her boyfriend on the mobile notices the train coming from behind at thundering speed only at the last moment when it is too late.

The gorilla experiment of Harvard University

The gorilla experiment was conducted by two Harvard psychologists, Daniel J. Simons and Christopher F. Chabris, in the late 1990s. In the experiment, a short video was shown to a group of volunteers and the video featured two groups of three each, one in white shirts and the other in black shirts, passing two basketballs.
The volunteers were asked to count the number of times the white shirt group passed the ball. While this was happening, another person dressed as a gorilla moved among the ball passing people. Those who were engaged in accurately counting the number of times the ball passed hands did not see the gorilla. In fact, when they were asked about it, about a half the audience had expressed surprise and remarked ‘What Gorilla?’ (available here).
The results were published by Simons and Chabris in a paper titled ‘Gorillas in our midst: Sustained inattentional blindness for dynamic events’ in Volume 28 of the journal ‘Perception’ in 1999 (available here).
In a subsequent experiment conducted in 2010, those who had heard about the gorilla previously had seen it, but had failed to notice the change in the colour of the background curtain from red to gold and a black shirt player leaving the game (available here).

What the experiment had revealed was that if the mind is focused on one thing, through conscious direction or due to emotional build-up, people fail to notice all other important things happening in their environment.

Research into inattentional blindness

The research into the inattentional blindness which the two psychologists had conducted has been published in the form of a book in 2010 titled ‘The Invisible Gorilla and other Ways our Intuitions Deceive Us’.
In this book, Simons and Chabris have argued that our brains have finite resources and to get the maximum out of those resources, the brains have conceived an ingenious way of resource allocation. That is, when the brain is called upon to address one issue by someone, his brain closes automatically for all others.
The problem which people face in such a condition, according to the two authors, is ‘the illusion of attention’ and people are often unaware of these brain limitations. People think that they see the world as really as it is but their vivid mental experience “belies a striking mental blindness”. Simons and Chabris have explored a series of illusions having to do with people’s perception, memory, knowledge and ability.
When memory is considered, it fades over the time and gets distorted by the beliefs, desires and interests which people are having. Thus, memories of significant events become just stories in the long run and are hardly ever accurate with the passage of time. That is why even the best eye-witness has to refer to his notes and refresh his mind about the incident in question if he has to give evidence on it after one year.
However, people tend to believe that they are correct and may even argue with their colleagues and friends to prove that point. But according to Simons and Chabris, the popular belief that people’s memories are objectively truthful is inaccurate and memory very often fails them both objectively and subjectively.

The illusion of knowledge and confidence

Another illusion identified by Simons and Chabris is the illusion of knowledge and confidence. Guided by this illusion, people normally think that they know more than what they know and better than they actually are. This illusion is known as “Lake Wobegon Effect” – a concept developed based on a fictional town in which “all women are strong, all men are good looking and all the children are above average”.

Demonstrating this effect, in a survey conducted by Simons and Chabris, 63 per cent of Americans thought that they were more intelligent than the average American when the average American could not be precisely defined by them. This leads to another illusion, ‘the illusion of potential’.
In this illusion, people believe that “there are vast reservoirs of mental ability in the brains of people which are untapped and just waiting to be accessed”. The end result of the two illusions combined is that crafty people can always mislead others to reap unearned benefits from them.
A good example is the popular TV advertisement which is currently shown on TV targeting the emotionally-driven mothers that feeding their babies with a certain brand of milk food will make them more intelligent.

‘Bounded rationality’ and ‘focusing illusion’

The findings of these two psychologists are consistent with ‘the theory of bounded rationality’ proposed by Nobel Laureate Herbert Simon and ‘the theory of focusing illusion’ developed by Nobel Laureate Daniel Kahneman and his co-researcher David Schkade. Herbert Simon argued that people’s rational behaviour is bounded by the limitations on time, resources and ability. Hence, though they are supposed to see the gorilla, they cannot see it.
Kahneman and Schkade argued that people guided by illusion always greatly exaggerate the importance of some factor which, according to them, causes the greatest impact on a large thing. An example is that if people believe that taking organic foods is beneficial to health, they ignore the important defects of organic foods. In other words, when they see what they expect to see, guided by focusing illusion caused by some emotional build-up, they fail to notice the big gorilla among them.

Emotionally-filled people cannot see the big picture

This general limitation of human beings is tapped by marketers, market drivers, preachers and politicians alike to their advantage. Since people are unable to see the big picture when their attention is focused on one aspect of reality or when their minds and visions are marred by emotions, it always pays someone to orchestrate a campaign to fill them with emotions and prevent them from seeing the big picture or in other words the gorilla present.
As long as the gorilla is invisible, markets are driven by people who make decisions on what they love to see ignoring the emerging big picture that may not be that favourable to what they have chosen. In other words, if they see the big picture, they may not make the choices which they normally make. Such emotionally driven decisions may sometimes turn out to be totally disastrous. That is why folk sayings advice people that they should not make important decisions when they are in anger, one of the most destructive emotions which a person could have.

The invisible gorilla in both bull-runs and bear-runs

Both bull-runs and bear-runs in stock markets are due to this type of choices made by people based on information acquired to satisfy their innermost desires.
Though market analysts come up with research findings as to what stocks people should buy for short term profits or what type of stocks they should buy for keeping as a long term investment, it is always easy for people to make choices regarding stock purchases following what others do known as ‘herd behaviour’.
So, if one can artificially create herd behaviour in some section of market participants, he can lead other people also to follow the herd and gain profits at the end. For instance, a rumour can be spread about the weakness in a given company. A shrewd marketer can get some pre-identified people to sell the shares of that company in the market.
The others who actually have no capacity to assess the situation on the company, because they do not see the invisible gorilla, will start dumping their shares in the market, thereby driving the share prices down. Once they reach the expected low price level, the persons who have spread the rumour can start buying the relevant shares in the market at a bargain price. This practice is known as ‘dump now and pick later’ strategy in share transactions.

Be cautious about ‘bull-runs’ too

In the opposite, a shrewd market participant who holds a significant volume of shares of a particular company can spread a good story about that company in the market. He then arranges with some connected parties to make some mock purchases of the stock in question, thereby causing its price to rise. The other market participants who do not suspect the orchestration of a wilful market manipulation, having just observed the price increase in the particular share, will start buying that stock pushing up its price further.
When the price reaches the expected high level, the original investor who has orchestrated the market drive will sell his stocks to gullible buyers who fail to notice the true developments in the market or in other words, the big gorilla that is present in the market. This practice is known as ‘pump and dump strategy’ in share market transactions.
‘Pump and dump strategy’ too facilitated by invisible gorilla
In the current bull-run in CSE, the market participants have been driven by desire to make quick profits by riding on the increases in the share prices. Instead of looking at the fundamentals of companies in CSE and making decisions based on such analyses, it appears that market participants have been following the herd.

Some analysts and journalists have spread stories about the market booming, preventing people from seeing the big gorilla present in the market. Since the herd has failed to notice the big picture and made its decisions based on what they have loved to see as shown to them by the writers, the end result would again be disastrous to the long term health of the market. Hence, the currently experiencing price increases cannot sustain themselves and in all likelihood, the market might switch over to the next cycle involving a bear-run in the market.

Can the CSE tackle the gorilla issue?

The failure to notice the big gorilla that has prevented people from seeing the big picture is an important issue facing the CSE. It is unlikely that the CSE will be able to tackle this gorilla issue successfully as long as some investors are able to keep the majority of market participants in ‘inattentional blindness’ – an ailment that blocks people’s views due to their being victims of some smartly-orchestrated schemes that have roused their emotions unknown to them.

*Writer is a former Deputy Governor – Central Bank of Sri Lanka and teaches Development Economics at the University of Sri Jayewardenepura. This article first appeared in Daily FT  – W.A. Wijewardena can be reached at waw1949@gmail.com