Recently, a message was doing the rounds on social media platforms. This message showed that the Nifty returns were 21% for the one-year period from 8th November 2016 to 7th November 2017. This period of course marks the one-year period since the Prime Minister Narendra Modi had announced demonetization of Rs. 500 and Rs. 1,000 notes on 8th November last year. While the start date was the date of the announcement, the end date was the first anniversary of the event.
The message suggested that the markets gave a 21% salute, which was somewhat akin to giving a 21-gun salute to demonetization. This may be interpreted as saying that the markets approved demonetization or that the rise in the markets was a direct outcome of demonetization.
In the financial world, one would come across many such messages where some linkage or connected is seen between two events. However, it is important to analyse whether this is just a coincidence or is there a correlation between the events.
Statisticians and researchers answer this question by looking at many observations. If the pattern appears more often, they conclude that there may be some correlation. In the absence of “statistically significant” number of observations, they rule out the hypothesis and conclude that this could simply be a coincidence and not correlation.
Getting multiple observations is not possible in this case, since demonetization is a rare event. Hence arriving at a conclusion based on just one event is a cardinal error. Those who understand probability would agree.
Since the data is not available, there is no way we can conclude whether this is a correlation or simply a coincidence.
Let us assume for a moment that these events are indeed correlated. Even then, it is important to check the cause-and-effect relation between the two events. Is the market appreciation a result of demonetization? How does one ascertain this? Once again, the only way to do so is to have a look at large sets of data, which is not available as mentioned earlier.
By the way, Donald Trump became the President of the United States on the same day PM Modi announced demonetization. Should we (and can we) say that the markets gave a 21-gun salute to Donald Trump? Guns seem to be more appropriate for Trump than for India going by what is happening in the US!
Be careful when you look at such reports. Humans are pattern-seeking animals. We try to identify patterns, even when one does not exist. Simple coincidences are presented as correlations and we tend to believe that one depends on the other. Let us be careful. Such reports make for an interesting reading but the same could be harmful to your portfolio’s health.
- Amit Trivedi
These are the author’s personal views. Amit is a leading trainer in the investment markets and is the author of a book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”.
He can be reached at firstname.lastname@example.org.