Expert Market Impressions
Alabama academic experts take some educated shots at tracking the quirks of stock markets.
We spoke with five Alabama professors who have published notable papers in recent years on stocks markets. Four are professors of finance and one — for baseline stability sake — a professor of psychology.
Cocksure Narcissists Roll High
Are you a narcissist? It’s OK. A lot of very well known and important people are. But just be careful when playing the stock market.
According to two studies co-authored by Dr. Joshua Foster, associate professor in the Behavior and Brain Sciences Program at the University of South Alabama, narcissists are prone to investing in risky stocks.
Foster and three other researchers have studied the connection between narcissism and investing, and the results were published in a paper called “Narcissism and Stock Market Investing: Correlates and Consequences of Cocksure Investing.”
The paper says, “The results of these studies suggest that narcissists are prone to investing in risky stocks. This tendency appears to stem primarily from narcissists’ hypersensitivity to reward (i.e., high approach motivation). Researchers have suggested that the motivational disposition of narcissists (i.e., high approach/low avoidance motivation) is likely to be adaptive in some circumstances and maladaptive in others.
“Investing in highly volatile stocks exposes investors to greater potential gains and losses depending upon market conditions (e.g., whether the market is in ascent or decline).
“Accordingly, narcissistic personality should be financially disadvantageous during periods of economic decline.” In other words, don’t trust a narcissistic broker when the economy is tanking.
Foster’s primary research focus has been narcissism, but he says it is hard to define.
“It is a term that has been used in psychology for more than a hundred years now, dating back to the days of Sigmund Freud, who wrote extensively on narcissism,” Foster says. “But it is a term that has also been highly controversial, because people have not agreed on what it means. What I would say is the general consensus now is that we have two types of narcissism, and the one that I studied and the one that this study pertains to is the one called grandiose narcissism. Their characteristics are they are highly outgoing, they tend to be very personable, they have good social skills, they tend to be assertive, they tend not to make a good first impression. They tend to garner positive attention to themselves, and they are exhibitionistic. They tend to have low empathy and have a hard time relating to other people.”
The studies used 71 University of South Alabama undergraduates who took part in exchange for credit toward their research participation requirement. Participants got instruction in economic concepts, a list of the 30 companies that made up the Dow Jones Industrial Average and an imaginary sum of $10,000 to invest in one or more of the 30 stocks.
“We had all the stocks listed by various characteristics, which included their beta value, which is a mark of their volatility, and we explained to the participants what all these things were, and, yeah, it did turn out people who were more narcissistic tended to pick stocks that had more volatility. And during this tracking period that we were following, the stocks that they were picking fell like a third in value during this time,” Foster says. “The more narcissistic people who picked the more volatile stocks lost the most money in the study.”
It should be noted that the study took place in November 2010, smack in the middle of the economic crisis.
“So when we started going through the financial collapse,” Foster says, “one of the things that was talked about a lot was the high level of risk taking that was occurring during and before this period” — with some of the banking industry so highly leveraged that even a slight fall in the value of their investments could have been catastrophic.
“That was obviously during a really unfortunate time in the American economy. We just happened to be running this study right before the largest collapse since the Great Depression in the stock market. It was obviously just luck.”
So what is the takeaway for the average investor?
“In terms of the individual investor, it is really hard to take a whole lot out of this study,” Foster says, “because we don’t really know ourselves, and we have a lot of bias.”
But, he says, an organization looking for someone who is going to have a role in investing company money might give prospective employees a second look if they fit the narcissism mold.
The Penny Ante Lottery
If you play any of the 44 lotteries in the United States, you might want to also look at some of the penny stocks, or low cap stocks, available these days. The chances of hitting it big are about the same.
“Buying a penny stock is like buying a lottery ticket,” says Professor Thomas Downs, co-author of a paper titled “Is There a Lottery Premium in the Stock Market?”
Downs, a retired professor of finance at the University of Alabama in Tuscaloosa, says he and a colleague worked on the paper for several years before it was published in the Journal of Portfolio Management in 2001. The research found that “extreme stock returns are associated with low-priced stocks, which, in turn, are correlated with a significant decline in average returns.”
They infer from this finding that investors in low-priced stocks accept lower (even negative) average returns for the chance to earn an extreme return. They refer to this sacrifice in average return as the “lottery premium.”
“Earlier papers grouped together all market outcomes, which gave a confused picture of the risk/return relationship,” Downs says. “We separated outcomes into the winning stocks and the losing stocks, and when we separated in-market outcomes we found a strong confirmation of the lottery premium.”
The paper defines the lottery premium as “the sacrifice in average return that investors pay for a chance to earn a huge although remote return. Analysis of more than 1.3 million stock returns spanning a 36-year sample period shows that the lottery premium is persistent and significant. It is higher on $1 stocks than on $7 stocks. It is greater in up markets than in down markets, and it is higher in the recent past than in the remote past.”
Downs says he and a research assistant started looking at companies whose stock returns exceeded 80 percent up or down in a month.
“What happened to those companies that their stock returns moved so much? None of these companies with big stock returns has any news about them. So we said, what is driving the stock returns if it is not news about them? I really expected when a stock is down 80 percent or up 80 percent there was an information reason, but, for nine out of 10 stocks, nope, no information reason.”
The lottery concept is attributed to former Federal Reserve Chairman Allen Greenspan, who told the Senate Budget Committee in 1999 that for investors buying low-cost internet stocks, the bigger the potential payoff, the more people were wiling to pay for a chance at winning.
“I think we found that the lottery premium is not stable over time. We found in down markets investors shy away from buying these low-priced stocks. The lottery premium seemed to be embedded in the low priced stocks,” Downs says. “We found that the lottery premium gets larger in up markets.”
Downs says stocks priced under $7 behave differently than higher priced stocks, and it is riskier in the sense that the low priced stocks have high volatility. “It doesn’t take long to be up 50 percent or down 50 percent if it moves from two cents to three or two cents to one.
“Large cap stocks have the stability. They just don’t garner those extreme swings. There is no way IBM is going to be up 80 percent or down 80 percent.
“If you want an 80 percent return on your money, and that is your objective, you are not going to be buying a large cap good stock. The only way you are going to get 80 percent return is to buy small priced stocks, these small companies, but that is not a good long-range strategy.”
Safe Harbor or Smokescreen?
One view holds that stock markets are just a “sideshow” and play only a small role in pushing money to investments, and, while stock prices reflect real economic conditions, they don’t affect them. Others argue stock markets actively impact economies in various ways, such as providing information for corporate managers about such issues as expansions, acquisitions, mergers and credit availability.
Albert Wang, associate professor in the finance department at Auburn University, and two co-authors tackle the issue in their paper, “Is the Stock Market Just a Sideshow?”
Wang and associates used the split share reform in China to further research the sideshow issue. During 2005–2006, the Chinese government implemented the split share structure reform, aimed at eliminating non-tradable shares such as the shares typically held by the state or by politically connected institutional investors that were issued at the early stage of the financial market development.
The analysis confirms that the split share structure reform was particularly beneficial for small stocks, stocks characterized by historically poor returns, stocks issued by companies with low transparency and weak governance and for less liquid stocks. Historically neglected stocks also increased in volume of trading and market prices. The researchers concluded that the reform laid the conditions for important future changes in stock ownership, liquidity and corporate governance in China.
“We found that there are marked improvements in firm profitability, productivity and investments after the firm’s stocks are allowed to be freely traded in the stock market,” the paper says. “Importantly, we show that the reform presents distinct impacts in the short and long runs. Our findings speak to the success of reforms towards stock market liberalization; but more generally, they speak to the role of the stock market in the economy.”
Also, Wang adds, “The idea is that most people think the stock market transaction as the investors just buying and selling stock; the corporate manager is just making the investment and financial decisions based on fundamentals and cash flows. So what does the stock trading mean to a corporation or the manager of a corporation?
“Well, first, more trading means more liquidity, and we know investors, especially retail investors, prefer holding liquid stocks. Second, liquidity also facilitates the market for corporate control, which gives more incentive to managers to improve firm performance. Last, but not least, liquid stock also provides more information for managers to evaluate the value of their corporate decisions.”
While the study is based on the Chinese market, Wang says the findings can be applied to all stock markets.
“It is important for the corporations to have liquid stock market transactions, but, on the other hand, from a government perspective, our paper shows that if the government decides to restrict some of the stock market transactions, based on our results, it is actually damaging some of the corporations.”
According to the paper, the Chinese split-share reform had largely positive effects on corporate outcomes. Unlike previous reforms, the state loosened its control over local companies by allowing all of their shares to be traded in organized secondary markets. The elimination of dual-structure ownership, as well as the easier access to financing, gave new incentives for shareholders and managers to increase firm performance.
“Our results suggest that sales, profitability and value increased because of the reform,” the paper says. “The increase in business performance is accompanied by an expansion of capital investment, followed by improvements in productivity. The reform also allowed firms greater access to equity financing and prompted them to engage in more corporate acquisition deals. The results we report shed a unique perspective on the role of public stock markets in the economy.
“In particular, they reveal the extent to which restrictions on secondary equity transactions can be detrimental to corporate growth. While our tests build on features that are particular to the Chinese equity markets, we believe our findings have broad implications for understanding the impact of governmental interventions and the trend towards capital markets liberalization. Our study indicates that trading in secondary equity markets have significant connections with outcomes observed in the real economy. Policies that ease restrictions on these markets may have positive effects.”
Politics and Poker
It may be a cliché to say that the stock market hates uncertainty, but if the first weeks of the Trump Administration are any indication, the market had best get used to surprises.
And while stock market movement is primarily a function of economic news, some studies suggest that political events many times are responsible for stock price movements.
One such study, co-authored by Professor Mohammad Robbani, chairman of the accounting and finance department at Alabama A&M University, analyzes the effect of political events on the prices of some stock indices in four emerging countries.
While Robbani’s paper was published about 12 years ago, he says the issues remain the same. “It is a continuing issue,” he says, “that we see time and again.”
Robbani and his co-author, Sekhar Anantharaman, selected one stock index each from India, Indonesia, Pakistan and Sri Lanka, all countries where the stock market was still developing.
The researchers chose the years 1997 through 2001 and examined the most important political events occurring and how those events affected the stock markets.
“We looked at two kinds of effects,” Robanni says. “We looked at the short-term effect and a five-day window around the event. We looked at stock indices two days before the day of the event, the day of the event, and two days after the event. Then we looked at the long term — a two-month window — one month before the event and one month after the event.
“What we found is that some of the events have in fact a significant impact on the stock market or the stock index.”
Robbani says the impact can be either positive or negative.
“But if you look at India, it is somewhat different from the other countries, because it is a democracy, and they are much more stable than many of the other emerging markets,” he says.
But, to the question at hand.
Can the findings of this research be applied to the United States? Can the highly contentious election of a full-speed-ahead administration in the United States impact the market?
The short answer is yes.
And, for the record, it appears Robanni’s thesis is correct. The U.S. stock market has surged since the election. In addition to elections, says Robbani, decisions made by the government can affect the stock market, as can legislation approved by Congress — in the United States just as in the countries studied.
Bill Gerdes and Elizabeth Gelineau are freelance contributors to Business Alabama. Gerdes is based in Hoover and Gelineau in Mobile.