Defend Truth


Are South African markets efficient?


Professor Tshilidzi Marwala is the seventh Rector of the United Nations (UN) University and UN Under Secretary-General.

When it was reported that the Minister of Finance Nhlanhla Nene had asked President Cyril Ramaphosa to release him, the Johannesburg Stock Exchange (JSE) All Share index decreased to its lowest levels this year while the rand also weakened. When President Ramaphosa announced that Tito Mboweni was the Minister of Finance, the rand gained 30c. Markets behave in a strange way. They respond to what is happening and very often in an irrational way. Are markets rational? Are they efficient? What do rational and efficient markets mean?

The English philosophers of the 19th Century, Jeremy Bentham and John Stuart Mill, formulated and advocated the utilitarian theory. The utilitarian theory is used to define rationality. In this regard, a rational agent maximises utility. Utility is the usefulness of a particular good or service. In this regard, rational market maximises the allocation and distribution of resources. A perfectly rational market is efficient, this is called the Efficient Market Hypothesis and was proposed by Economics Nobel Prize Winner Eugene Fama. If markets are not efficient, then they misallocate resources resulting in undeserving traders gaining from the markets and deserving traders losing in the market and, consequently, depressing the economy. Who are these deserving and undeserving traders? In simple terms, deserving traders are those that use the gain they derive from the markets to further expand the economy whereas undeserving traders are those that use the gains they derive from the markets to impair the economy.

Why do inefficient markets harm the economy? In 2000 the company, which specialised on booking services such as airlines and restaurants in the last minute was making £330,000 profit. was then floated in the London Stock Exchange and its valuation reached £768-million before it crashed. The market was irrational on its view of this company and, consequently, inefficiently allocated resources to this company and this was bad for the economy. This market inefficiency was due to inaccurate information on the value of the Company.

Another market inefficiency due to limited information is the company Steinhoff International, which dropped from a market capitalisation of R104-billion in 2015 to R9-billion in 2018. It seems the management of Steinhoff International deliberately withheld information from the shareholders and this was costly to the South African economy.

Coming back to the topic, is the South African market efficient?

It is generally believed that markets are not efficient. There are several reasons why this is the case and one of these is because markets contain the behaviours of people who are participating in the markets and these behaviours are often erratic. In essence, markets reflect real information, such as the output of the mining sector which is rational, and imaginary factors, such as the attitude of traders towards mining which can be irrational. The mathematical field of Complex Analysis prescribes that nature can be represented in two forms, these are the imaginary and real axes. The behaviour of the market, going up and down because of the changes of Ministers for example, is because the market is also driven by imaginary factors emanating from human behaviours.

In his book Thinking Fast and Slow Nobel Prize Laureate Daniel Kahneman studies the behaviour of human beings when they make decisions. Some of the observations that he makes is that human beings truncate complex problems, solve simple ones and that when they make decisions, they focus on avoiding losses at the expense of making gains. This simply means that human beings do not make rational decisions as they never maximise utility. This also means that the markets which are populated by human beings are significantly influenced by human behaviours and, therefore, cannot be efficient.

The JSE used to be located in downtown Johannesburg. Trades were made by human beings who shouted for particular stocks at a particular prices. To succeed in that stock exchange, one needed to be tall and have a loud voice. The recruiters of people who traded on the stock exchange floor specifically looked for height and voice, which was discriminatory. The JSE then moved to Sandton and entered the electronic age. Heights and voices are no longer competitive advantages but digital literacy, data analytics and artificial intelligence (AI) have become competitive advantages. In this new JSE, proximity to Sandton is a competitive advantage, because if a person in Thohoyandou trades via the internet then his/her trade arrives at the JSE slower than the trade which is made from Sandton.

Today people are making these trades at a faster pace and this is called high frequency trading. In my book Computational Intelligence for Economic Modelling, I describe how AI is changing the practice of trading and ushering in intelligent high frequency trading. The effect of the confluence of faster computers, AI, high frequency trading and advanced data analytics is making markets more efficient than when markets were populated by just human beings. Markets that use AI and advanced data analytics are markets of the fourth industrial revolution.

Why are fourth industrial revolution markets becoming more efficient and what are the implications of this change on the economy and society? The first reason why markets are becoming more efficient is because we remove behavioural characteristics from the markets when we insert automation, AI and advanced data analytics into trading. The second reason is that we are now able to understand the character of financial data. For a long time, we reduced analysis of financial data to simple statistical concepts such as averages and variances. With advances in data analytics we can now break data into its various components and spectrum and, thus, make machines understand data much easier. With advances in deep learning we are able to analyse data in its entirety rather than in truncated and sampled forms. The third reason is advances in computer power, which makes it possible for financial companies to acquire supercomputing capabilities and be able to implement intelligent algorithms on big data more efficiently. The fourth reason is that we now have more information and technology to analyse both structured and unstructured data.

The rate at which markets are becoming efficient varies depending on the state of development of countries. In his book AI Super-Powers: China, Silicon Valley and the New World Order Kai-Fu Lee describes how the United States and China are becoming the only superpowers of the fourth industrial revolution. In this regard, if we do not invest heavily on AI and big data countries that do will exploit inefficiencies in our market to our detriment. Eleonore Pauwels studied the geopolitics of artificial intelligence and observed that the amount of money invested into AI start-ups between 2012 and 2016 was $17.9-billion by the US followed by $2.6-billion by China and then $800-million by Canada. Eleonore concluded that given this asymmetry of investments, countries that lag behind are going to be cyber-colonised. Coming back to the concept of market efficiency, countries that do not invest into the technologies of the fourth industrial revolution will have inefficient markets resulting in inefficient allocation and distribution of resources as well as impaired economy.

What kind of skills do we need to produce a workforce that creates efficient markets and, consequently, robust economy? First, we should produce a cadre of people who understand AI and big data and how these technologies interface with the economy. Second, we should develop leadership courses that re-skill existing workforces in industry, government and society so that they can better manage the fourth industrial revolution markets as well as craft the associated legislations and strategies.

Finally, the reason why there were movements of the markets during Ministers Mboweni and Nene’s movements in the Ministry of Finance is because the South African markets are not efficient. DM


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