What is Capuchinomics?
Capuchinomics is a financial newsletter that uses human behavioral trends and patterns as the primary factors in analyzing the prices and values in financial markets and securities. These patterns and trends are evaluated through monitoring political, economic, demographic, financial and numerical data. In addition we pay attention to social preferences and biases, cultural choices and prejudices, religious priorities, semantics. We monitor these factors by accumulating insights, observations, hypotheses and conclusions from observations sources available through newspaper articles, periodicals, books, magazines, blogs, scientific studies, web sites, chat rooms, financial reports, newsletters and day-to-day living. Information from these sources are combined with our experience and knowledge in traditional fundamental financial/securities analysis and technical analysis to determine potential investing and speculative opportunities.
What is the basis for behavioral finance?
Ten years ago, a biotech analyst posed a question to a room full of portfolio managers: why are biotech stocks such as Amgen so volatile? Their sales, profits are margins are quite predictable but yet the stocks are extraordinarily volatile. A conundrum. Stable business, volatile stocks. Shouldn’t the performance of the stock mirror its financials the analyst asked? This question was the beginning of a discovery and eventually an investigation into the alternate ways to view, analyze and make decisions about investments in financial markets and look at this world through some lens other than the one suggested by the rational man model and efficient market theory.
The rational man model and efficient market theory does not and we argue cannot provide answer to these questions:
-Why do companies with stable cashflows, earnings, sales and profit margins have such volatile stocks?
-If the prices of assets are perfectly efficient why is there so much turnover and trading in stable asset classes like treasury bills?
-IF asset prices are correctly priced, why is there so much volatility? The average band of most stock prices measured as a function of their 52-week high and low is nearly 100%. Does it really mean that such extraordinary amounts of value created and destroyed in such a small time frame?
As we began to ask questions, the doubts began to mount. The more we examined the issue we realized that the answers lay in examining the direct the cause of these events — human behavior and decisions.
The more one begins to consider problems with efficient market theory, one can begin to see more and more problems. For example, , why is a company in the biotech industry with 25% earnings growth and 80% profit margins is more valuable and/or more volatile than a company with the same characteristics in the furniture business. Biotech companies that sell life saving drugs are highly valued while a furniture maker with equivalent characteristics is valued at a fraction of that price. If a dollar in biotechnology is equivalent to a dollar in furniture manufacturing, efficient markets posits that these two companies accounting for some small non-arbitrageable differences (nationality, tax rates, etc.) should have similar values. Markets and investors have their own logic and value the biotech company much more highly.
The answers for this and other questions we pose we believe lie in the human psyche, which does not value all dollars equally and is influenced by feelings and emotions and consequently perceives differences where there are none. Biotech is exciting. The industry is analyzed and invested in by a very small group of investors whose motivations and views determine the valuation of these companies. Furniture manufacturing is boring. This industry is perceived to have low growth and a fast growing company in this business will be perceived as being of less value than and equivalent biotech company.
Human beings derive we believe differences on the basis of factors other than rationality. In the above example of the valuation of biotech companies, one can see that the organization of markets and selective enthusiasm for a particular field can lead to high valuations. Behavioral finance is a catch-all term for these phenomenon in economics. Behavioral finance attempts to explain that which is inexplicable through the rational rubric of efficient market theory — events such stock market crashes and bubbles, unemployment, excess production and other deviations that do not comport to the classical economic model.
The classical model suggests that market participants pursue objective, rational, optimization of economic utility in decision making all the time. While this is often true, it is not always true. Sometimes these periods of irrationality or inefficiency can last a long time. The impact on financial markets then are mispriced assets, sometimes for long periods of time.
Behavioral finance is the main process engine for content on Capuchinomics. We attempt to evaluate the emotion in a security’s valuation attempting to locate extremes that might warn of unappreciated risks or provide unseen opportunities. Capuchinomics was among the few newsletters to correctly anticipate the magnitude of housing bubble and the catastrophic consequences it would have have for the financial system. If you would like to see a copy of our final edition of the previous version of Capuchinomics, please e-mail us at capuchinomics.at.gmail.com