Sensex

Is it Fundamentals or Sentiments?

SENSEX fell 257 points & closed at 17,232 on 12th July after poor results posted by IT giant INFOSYS. According to Analysts besides skepticism prevailing regarding revenue growth, the sentiment for IT sector dampened as INFY did not release its outlook for the second quarter of 2012-13. The sentiments of investors play a very significant role in determining the fortune of any stock. Even our PM Dr. Manmohan Singh has recently affirmed that reviving the investors’ sentiments by policy measures is the top priority now.

What are these sentiments? They can be defined as erroneous belief of investors on prospects & future trends that are quite unwarranted by the macroeconomic fundamentals. The traditional financial theory of Efficient Market Hypothesis propounds that markets are perfect & investors would always behave rationally while the Capital Asset pricing theory talks about rationality on part of investors based upon future cash flows & returns. But these theories find no room in the real market which is driven exclusively by sentiments of investors.

After path breaking reforms that took place in 1990s, a new domain of Finance emerged which envisaged that there are widespread anomalies in the markets leading to market inefficiencies & irrational behavior of investors who are driven by sentiments & also Herd mentality. This area of finance & investors psychology is widely & commonly known as Behavioural Finance which illustrates that human beings make decisions not only with their mind but also with their hearts. Most of their life’s decisions are purely based upon emotional considerations. Behavioural finance offers much more flexible models of investor attitude & performance that are seen as sensitive to fluctuations in sentiments. Taking this new thinking in the backdrop there is a need to devise a specific Index which can factor in the investors’ psychology as well, besides taking...