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Rationalising Irrationality

Cognitive dissonance is the process by which our brain tells us that what we are doing is right. In most spheres of life, it's all right to be run by it, but not in the sphere of investments

Half a century back, someone proved it in a laboratory and gave it a name: cognitive dissonance. We amateurs have always known it exists in our wives, although we have trouble accepting its existence in our own selves.

Cognitive dissonance is what makes us continue making a fool of ourselves even after we should have found out that we are (making a fool of ourselves). As teenagers, we all remember trying to make our first crush (the girl next door?) laugh, mindless of the fact that she was laughing at us, not with us. Our friends could see it very clearly, but our love -sodden selves just could not. Looking back on it, how could we? …But we did, and we continue to behave in similar variants of such stupid, unexplainable-in-hindsight beha-viour. Since lesser mortals don't have the ability to stand back and look at themselves, it is left to writers, academics and sundry world-watchers (like me) to scratch their heads and come up with explanations for what is going on. And since the audience is usually made up of (lesser) unevolved beings, the loudest voice carries the day.

'India is happening', no doubt about that. Repeated ad infinitum, this 'truth' glosses over any ifs and buts. Those will be simply realised in hindsight, and rationalised away with some fresh justification. Did you buy IT stocks in Jan- March, 2000? If you did, have you ever sought an explanation from yourself? More important, what answer did you give yourself? Give yourself this little test to see whether you are prone to catch this disease.

You will always get punished for this flaw in your thinking. And there will be no requiem.

Ok, let me start at the beginning. cognitive dissonance is the process by which the brain justifies (to itself) its actions and perceptions. It is the part of your id, your sense of being, your sense of identity. It is what makes you call yourself a genius, when bystanders think you are a fool. It is part of your “psychological immune system” which retrieves your sense of well-being, your self-worth, after a decision, or choice that you have made. It is what makes you spruce up your auto-rickshaw with garish pictures of film stars in the name of style, the 1990s habit of the Punjabi puppy re-decorating his Mruti with 'accessories', the current habit of the Punjabi Mummyji of rejuvenating her 'personality' with the latest plastic 'lifts'. The professor who holds forth (I have often shuddered at the prospect of being told by some of my students that I am a victim of the same syndrome) and the politician/ media-man who gets onto a soapbox and launches into the infinitum…surely you have seen one or the other specimen?

There is a positive side to all this. Cognitive dissonance is what makes you think your wife is prettier than the neighbours', or nicer, or whatever it is that you think your wife is better at…! It is the 'nasha' under which you prod your five-year old besura son to render the latest film number in front of a thoroughly bored, plasticine-faced crowd of guests at the society's Diwali Mela. That may do nothing for your reputation as a bore, but will do plenty for your son's 'public-speaking' track record, so valuable an asset, any MBA will tell you..! It helps you go up to the pretty foreigner in the train… “Hello. Myself Hari Prasad from Bulandshahr,” which the foreigners mistake for "Indian hospitality"! Helps tourism, y' know! This is not to be confused with post-purchase dissonance, a.k.a. 'buyer's misery'. That is the Dr Hyde to the above-mentioned Jekyll, the part of you that is always unhappy or paranoid with whatever he has, or wherever he is. So let me quickly establish the relevance of this article with the current market situation. If you have bought a power company at Rs 22 crore per existing mw, or a real estate company at 5 per cent of the GDP or an infrastructure company at >50 times earnings, you need some serious cognitive dissonance to keep your sense of self worth (or should that be net worth?) intact. Every serious bubble has some new 'technical concept' to justify the then current reality. It is the fools' way of saying "this time, it is different". In 1992, there was the Replacement Cost Theory that confused dollar prices with rupee valuations. I remember the great Dr Yasaswy giving a lecture at none-other-than the Institute of Chartered Accountants to explain the Harshad Mehta theory. Too young for that, were you? In the IT and dotcom bubbles, these companies were 'changing society', killing the business cycle and increasing economic productivity to infinity. Too long a point for such a small column, the less said about that, the better. Anyway, those companies are still around, so you can ask them what they have to say for themselves? Not their fault really, you can't save the fool from himself.

Today's justification is “India Shining” and “sum-of-parts” valuation. The first is obvious, you tell me more about it, never mind that we have a trade deficit and oil-price sensitivity that puts us abreast of America as far as the twin deficits go. A serious threat of an inflationary shock, with an irresponsible government distorting energy prices to create a short-term shield against inflation. When the dam breaks, the rupee could surprise the whole of corporate India. Today's stars with their huge capex plans, could bite the dust in a manner that our good ole' fools cannot comprehend. Did you know that every major corporate in Delhi has bought some sort of yen carry trade, which knocks in a serious digital at 105+. That means, at 105 or higher, their protection expires and they have to pay at market, loans that they took at 115-122. In simpler words, a 10-20 per cent increase in principal value of the loan that could reverse whatever 'carry' they may have made, i.e. the savings in interest cost of 2-4 per cent that they have been making for the last few years. Watch the yen : dollar rates very closely, that is like a one-time interest rate spike that most people can't see coming. And when you run out arguments, there is this "sum-of-parts". This consists of valuing translucent subsidiaries either on operating margins, or on some fuzzy 'slice-of-potential market', which may or may not happen. Like those big “J-curve” valuations on which the dotcoms were sold…you know, those presentations where the 20-something 'entrepreneur' would look up dreamily at the fan, roll back in his chair and start, “the population of India, no, the world is…” It didn't stop there. You now have this 'theory' going something like this: all holding companies, should be based on the value of their shareholdings in other operating companies. So you get Rs 1 lakh crore in the operating company, another Rs 1 lakh crore in the holding company, another Rs 1 lakh crore in the holding company to the holding company and it goes on and on…….till the bull market is over, or you run out of fools. And these valuations are now at a few per cent of GDP each!

In one spectacular case, a research report by one of the top foreign banks points out a negative cash flow for the next three years and then uses replacement cost value method to value the company. So I suppose it is 'normal' to lose cash for three years before you generate a profit, mind you, in a running company. In another, a price target is revised 400 per cent just because the stock went up, using the aforementioned 'sum-of-parts' value, the major part of which is just a contract! Just like during the IT boom, when valuations would increase when an 'order' was received.

I won't comment on the individual merits of these specific stocks. Just find the fellows who are buying these stocks and hear their justifications. Just back from Jaipur, where a relative told me that the above-mentioned would 'double in a month'.

For once, I did not hesitate to touch his feet!