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Stock market trading lessons from wild swings in onion prices.

Date: 04-02-2019
Subject: Stock market trading lessons from wild swings in onion prices
Onion prices periodically cause grief to the consumers and at times cause grief to the farmers. A simple Google search will show articles mentioning how prices of onions have touched Rs 100 per kilogram and consumers have cut consumption and also show articles where the price has dropped to Re 1 per kilogram and that farmers are in distress because they are not able to get a fair price for their produce.

Now imagine a scenario where a restaurant owner who was famous for serving “Kanda Bhajiya” (onion fritters) in his restaurant quit the restaurant business and sold the premises when the price of onions touched Rs 100 per kilogram. Also a farmer who sold her farmland based on one season of low profitability because of onion prices of Re 1 per kilogram. You would call that crazy, right? All of us know that there are temporary shifts in supply and demand which cause these temporary aberrations in price. One cannot take a long-term business decision based on these temporary aberrations.

However, it is in this manner that the marginal investor in the stock market behaves. Take the example of a company like Interglobe Aviation. This company runs airline operations in India under the brand name of IndiGo. The shares of Indigo were trading at a price of Rs 1,503 on April 20, 2018. In less than six months, on October 9, 2018, the share price of IndiGo had fallen to Rs 725, a fall of more than 50%. As at the time of writing this article, the shares are quoting at Rs 1,120.

What caused this fall and the subsequent rise in share prices? Are there lessons to be learnt from such share price behaviour?

One of the major cost factors for an airline is the cost of Aviation Turbine Fuel (ATF), which is based on the price of crude oil. Further, ATF and crude oil are global commodities which are priced in terms of US Dollars. Given that India imports a lot of crude oil, in the past, whenever there has been a spike in the price of crude oil we have seen that the Indian rupee has tended to be weaker against the US Dollar.

In the month of October, brent crude oil had risen from around $65 to around $86. The Indian rupee had weakened from about $1 = Rs 65 to Re 1 = Rs 74.60. Again, aircraft lease payments are usually determined in US dollars and they would also go up in rupee terms in case of a weak rupee. All this will obviously cause a spike in operating costs for airlines and profitability will be under pressure. Small wonder then that an airline which has otherwise been reporting profits reported a loss of Rs 652 crores in the September quarter.

Will this quarter's results be representative of the future for all time to come? Probably not. Firstly the price of crude oil and rupee bounce around a lot but settle down over a period of time. Also any cost which affects the entire industry will eventually be passed on to the consumer. Hence, air ticket prices may go up if the cost increases are permanent. As we have seen, the price of crude oil came down, the Indian rupee strengthened and IndiGo's share price rebounded.

The kind of investor behaviour which causes the share prices of IndiGo to go up to Rs 1,500 down to Rs 725 and back again to Rs 1,120 is the result of two behavioural biases called recency bias and naive extrapolation. Recency bias tends to overweigh recent events and forgets lessons from history and naive extrapolation projects the current trends into the future mindlessly without considering the possibility of the trend reversing.

Investors forget that in the not too distant past in March of 2012, Brent crude prices had gone up close to $ 130 and then had crashed to below $30 per barrel in January 2016. The media headlines of today and yesterday determine investor behaviour rather than even history as recent as 2-6 years old. Not only this, when prices have already risen, we project that they will continue to rise and when the fall, we think that they will continue to fall.

Our investment behaviour would dramatically improve if we consumed financial news that was a few years old rather than the current news. For the lay investors who are feeling bad about the investment mistakes they have made in the past after reading all this, take heart. Even seasoned businessmen make the same mistakes.

A reputed business house got into trouble by buying steel assets at the peak of the steel cycle and has many lost years post that. The best course of action for investors is to be aware of this tendency and make the tendency work for you by going against the herd rather than participating in the herd behaviour.

Source: moneycontrol.com

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