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Destructive “groupthink” versus rational analysis

29 April, 2013

60 years ago, the great social psychologist, Solomon Asch, did all of us a big favour. Through a series of brilliantly conceived experiments, he showed that: (a) most of us suspend belief in our own judgments when confronted by the judgments of a larger group; and (b) we find it hard to disobey the orders of “authority” figures. 

These takeaways can be applied to the stock market. In particular, given the mood prevalent in the market today, “conformist” brokerage research (which recycles newsclips pertaining to beleaguered companies/sectors and negative commentary by bankers) can easily create adverse herd behavior in the Indian market.

My colleagues and I do not agree with much of this negative ‘groupthink’. At the level of the company, the economy and the stock market, our attempt has been cut through the noise, to think rationally and, most importantly, to think for ourselves.

The ‘CTRL C, CTRL V‘ club

Just as in bull markets, when there is no shortage of brokers publishing euphoric thematic about India (complete with professional artwork, glossy covers and hard binding), in bear markets, you struggle to find rational analysis of when the market will turn. Instead, in difficult markets, brokers often choose to give their pens and pencils a rest and try to avoid making too many phone calls to clients. When they do pick up their pens, it is often to recycle news clips about beleaguered companies/sectors or to narrate personal anecdotes about thinning crowds in shopping malls and the challenges of the white-collar job market.

…and how it hurts investors

Such analysis would not be of import had all of us – as investors or as market pundits – been rational creatures. Instead, as psychologists have shown graphically over the last 50 years, we let go of our senses at the slightest prompting to do so.

In a series of experiments conducted in the 1950s, Solomon Asch, a brilliant social psychologist, demonstrated our frailties. Given a simple task, such as comparing the length of four wooden sticks and pointing out if one of them was the odd one out, people almost never erred when asked to decide on their own (without seeing the judgments of others). However, when put in small groups of, say, five people, when everyone else had been told by Asch to give the incorrect answer, people erred one-third of the time. Thus, even whilst making a simple judgment, individuals were willing to suspend their belief in their own senses and go along with the verdicts of random strangers.

Now suppose the judgment at hand is a more complex eg. Will the economy recover? Will the rupee appreciate? Will the stock market rally? Suppose further that rather than random strangers prompting the answers, the prompting is coming from authority figures – senior bankers, powerful promoters, etc. What effect would that have on us? Asch conducted another set of experiments which sheds light on how our brains react when prompted by authority figures.

In an experiment (originally conducted to understand how perfectly normal people ended up helping the Nazis execute the Holocaust), Asch showed that volunteers were willing to apply fatal electric shocks to those who got quiz questions wrong provided they were prompted by an authoritative-looking man in a white lab coat to do so.

You can now deduce what happens to most of us when an establishment figure opines in public about the fate of the economy, the current account deficit, the stock market, etc. It is in this context that lazy research can drive damaging groupthink on critical matters pertaining to our collective well being.

Two different dimensions to think about

A fundamentally oriented investor has to think along least two specific dimensions:

  • At the company level, after in-depth research, including primary data checks and forensic analysis where possible, investors need determine the relative merits of a company without agonizing about what the rest of the market makes of the stock. 
  • At the economy level, investors need to take a balanced view on the economy i.e. not get swept away by the euphoria of an economic boom or be driven to despair by a downturn. Obviously, this is easier said than done and therein lies the challenge for the contemporary naysayers. 

(Saurabh Mukherjea is the Head of Equities at Ambit Capital. The views expressed here are his own and not Ambit Capital’s.)

To become a guest contributor with VCCircle, write to shrija@vccircle.com. 


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1 Comment
Varadha . 4 years ago

Saurabh

Very well said – I have always believed that investing is a very individual, lonely affair – so it is critical that when one works in team, everyone gets fair share of their voice and opinions are respected for what they are, rather than the hierarchy of the mouth that voices them. That, if anything has been consistently the hallmark of great investors – humbless and a willgness to cut losses and accept if they are wrong.

Destructive “groupthink” versus rational analysis

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