Insights From Behavioral Finance: Parameter Uncertainty

Although behavioral finance may at first seem to be far removed from the kind of rigorous analysis required by the discipline of value investing, it is actually at the core of what value investing is all about. After all, one of the central tenets of behavioral finance is that humans are not mechanical utility maximizers, whose actions can be predicted by models that presuppose rational action. Rather, they are subject to a wide range of emotional and cognitive biases, a topic that we have explored previously.

Fuzzy models

This sentiment is quite similar to classic value investing metaphors such as “Mr. Market” and the concept of irrational exuberance. Indeed, value investing presupposes the market can be highly irrational at times, as this is what allows diligent practitioners to pick out undervalued stocks. Another key insight from behavioral finance is that of parameter uncertainty – the inherent fuzziness of financial models.

The implications of parameter uncertainty are twofold. First, it makes it very difficult to put an exact number on what the value of a business should be. Now, for most value investors, this is not a big issue. For instance, Charlie Munger (Trades, Portfolio) has often said he greatly prefers to have a range of possible values for a business, rather than a specific number.

There are many reasons why this is preferrable. For one, it is easier to do. For another, it enables an investor to establish an adequate margin of safety. And finally, it is simply the more intellectually honest thing to do. With this in mind, the exact price targets set by so many sell-side analysts begin to look suspicious. Exact numbers convey certainty and authority, which is why they appeal to so many people. But they are no better, and are often far worse, than ranges. By tying ourselves to exact targets, we narrow our margin of error and open ourselves up to a greater possibility of being wrong.

The categorization problem

The second implication of parameter uncertainty concerns the problem of categorization of investment targets. In a world where corporations are based in many different countries, how does one ascertain the risk associated with any given company? In 1990, Robert Reich, who would go on to be U.S. Labor Secretary from 1993 to1997, wrote an article in the Harvard Business Review titled, “Who Is Us?” which examined this exact question. Is a U.S.-based and listed company that conducts most of its business in the developing world more representative of the U.S. market than a foreign company that primarily employs American workers? Which is riskier?

The truth of the matter is different individuals and institutions will pick their own definitions for these things. Moreover, they will have to grapple with problems like whether Amazon (NASDAQ:AMZN) is a cloud computing company or a retailer and whether or not China should still be considered an emerging market. Of course, each will come up with their own answers. The problem is when so many different market participants have different ways of viewing the world, it is somewhat difficult to build reliable predictions of how they will react in the future.

Summary

Behavioral finance has a lot to offer value investors. While traditional thought holds that all market participants share broadly the same goals, outlooks and decision-making calculi, the truth of the matter is all of this is incredibly subjective. Parameter uncertainty is a particularly good example of this as it touches on so many different aspects of investing. As investors, there is no way to overturn uncertainty – so the best thing to do is embrace it, not ignore it.

[“source=gurufocus”]

World leaders head to Davos as uncertainty darkens the global outlook

A demonstrator holds a 'Stop The Shutdown' sign during a rally with union members and federal employees to end the partial government shutdown outside the White House in Washington, D.C.

Andrew Harrer | Bloomberg | Getty Images
A demonstrator holds a ‘Stop The Shutdown’ sign during a rally with union members and federal employees to end the partial government shutdown outside the White House in Washington, D.C.

As a legion of heads of state and business leaders head to Davos for the annual World Economic Forum (WEF) next week, world affairs are as unpredictable and unstable as ever.

In the 12 months since the last forum, global trade relations and diplomacy as well as domestic politics have been fractious, to say the least.

Since President Donald Trump first announced tariffs on a selection of Chinese imports last January, the U.S. and China have gone on to impose tariffs of $250 billion and $110 billion on each other’s goods, respectively. Washington is currently witnessing its longest ever shutdown because of an impasse over funding for a border wall and Brexit remains as chaotic and unclear as ever just weeks before the U.K.’s departure from the EU.

The forum released a “Global Risks” report Wednesday in which it noted that “global risks are intensifying but the collective will to tackle them appears to be lacking.”

In continental Europe over the last year, we’ve seen a populist government take charge in one of Europe’s major economies, Italy, and a demise of mainstream politicians that could lead to a power vacuum — and moral crisis — in the region.

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German Chancellor Angela Merkel announced in October that she is to retire from politics and her party continues to cede voters to the left and right, meanwhile an increasingly unpopular French President Emmanuel Macron is dealing with ongoing and often violent protests on the streets of Paris.

John Drzik, president of Global Risk and Digital at risk management firm Marsh, told CNBC that cybercrime, critical infrastructure and environmental threats, as well as changes in geopolitics, are among the biggest risks facing the world right now.

“The rise of nationalist agendas around the world is creating friction among states as well as weakening multilateral institutions,” he told CNBC’s Joumanna Bercetche.

“It’s not just in the U.S., here in the U.K. you have Brexit, but in Brazil, Italy, Austria and Hungary there are lots of populist political figures who are getting elected and changing the agenda to be more protectionist and more nationalist and, as a result, weakening the multilateral bonds that were there and that’s expected to continue into 2019.”

The global economy is not looking too great either as trade concerns continue to concern business and rattle financial markets.

The International Monetary Fund (IMF) cited trade tensions when it downgraded its global growth forecast for 2019 last October. The IMF expects global growth of 3.7 percent in 2019, down 0.2 percentage points from an earlier forecast in its World Economic Outlook report.

The World Bank, meanwhile, sees global growth at 2.9 percent in 2019 amid tightening financial conditions. The European Commission is also downbeat about the region’s growth, forecasting a lackluster 2 percent growth in the EU in 2019.

Globalization 4.0

Against this backdrop, there’s plenty to talk about at this year’s Davos then when the heads and officials of over 100 governments meet, as well as top executives from over 1,000 global companies. Designed to foster private and public cooperation, the forum’s main objective is “to improve the state of the world.” This year’s theme is focused on “Globalization 4.0.”

WEF’s founder Klaus Schwab said in November that the world is experiencing “an economic and political upheaval that will not cease any time soon” adding in a WEF editorial that “the forces of the Fourth Industrial Revolution have ushered in a new economy and a new form of globalization.”

Schwab said that a slow and uneven recovery since the global financial crisis meant “a substantial part of society has become disaffected and embittered, not only with politics and politicians, but also with globalization and the entire economic system it underpins.”

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He said populist discourse had confused globalization, which has been seen to have negative connotations in some populist narratives, with globalism.

“Globalization is a phenomenon driven by technology and the movement of ideas, people, and goods. Globalism is an ideology that prioritizes the neoliberal global order over national interests. Nobody can deny that we are living in a globalized world. But whether all of our policies should be ‘globalist’ is highly debatable.”

Put simply, Schwab said the challenge for global leaders is “to restore sovereignty in a world that requires cooperation.” He advised that rather than closing off economies through protectionism and nationalist
politics, a new social compact is needed between citizens and their leaders, so that everyone feels secure enough at home to remain open to the world at large.”

“Failing that, the ongoing disintegration of our social fabric could ultimately lead to the collapse of democracy,” he said.

[“source=cnbc”]

Wipro Steps up Local Hiring in US Amid H-1B Visa Uncertainty

Wipro Steps up Local Hiring in US Amid H-1B Visa UncertaintyWipro Ltd, India’s third-largest software services exporter, said on Wednesday that more than half its workforce in the United States consists of locals after it hired more than 1,600 people in the last six months.

The statement comes as US President Donald Trumphas asked federal agencies to review a visa program that Indian IT firms such as Wipro use to fly engineers to the United States to service clients.

A tighter visa regime could force Indian IT companies to step up local hiring in their biggest market, potentially increasing costs and hitting margins.

Wipro rival Infosys Ltd last month said it planned to hire 10,000 US workers in the next two years and open four technology centres in the United States.

Over the past couple of quarters IT clients slowed down discretionary spending, hitting growth in India’s $150 billion information technology sector.

A leading lobby group for India’s IT industry last week forecast that the sector’s export revenues would grow at 7-8 percent for the year to March, as the industry faces continued headwinds from the US market.

Wipro said on Wednesday that more than 3,000 locals joined the Bengaluru-headquartered firm in fiscal 2017, increasing its total headcount in the US to 14,000. It is also said it is working on expanding its centres in Tampa and Dallas.

“We will continue to build a strong local talent pool with diverse skill sets and make strategic investments in close proximity to our clients to serve them better,” Wipro Chief Executive Abidali Neemuchwala said.

In a regulatory filing earlier this month, Wipro said “significant developments” under the new US government could pose a risk to its business there.

[“Source-ndtv”]

Economy set to ‘shift down a gear’ amid political uncertainty

Brexit talks are under way

Economic growth is set to be “subdued” over the next few years amid ongoing political uncertainty and Brexit talks, a leading business group is warning.

The CBI said a slower pace of growth is expected to persist, while business investment will fall back next year.

Household spending growth is predicted to slow this year and in 2018, while wage rises will remain below inflation this year and broadly in line next year, said the CBI.

The group forecast 1.6% economic growth for 2017 and 1.4% next year.

Carolyn Fairbairn, the CBI’s director general, said: “Growth should be steady, if restrained, over the next couple of years as the pace of the economy shifts down a gear.

“While the country’s exporters should emerge as a real catalyst of growth, rising inflation and stubbornly low wage growth mean that people are already starting to feel the pinch.

“Tighter purse strings mean slower household spending growth and uncertainty is likely to weigh on the minds of those making major investment decisions.

“So, after a frantic period in Westminster, this is the time for a renewed focus on the economic fundamentals of this country.

“Above all, the new Government has the opportunity to signal loudly and clearly that Britain is a great place to do business, relentlessly focusing on investing in infrastructure, innovation and skills nationwide, while delivering a sensible and competitive tax and regulatory environment.”

Rain Newton-Smith, the CBI’s chief economist, added that growth will be slower in the years ahead as living standards are hit by rising inflation.

[“Source-ndtv”]