How the Markets Work

yeah babyIf you doubt that humans herd like crazy or that good trades — and even decidedly mediocre and unoriginal trades — get crowded so as to limit or eliminate their advantages, watch this short video.


The Consequences of Crowding

overcrowdingIt is axiomatic in the investment world that as an approach, sector or asset class becomes more popular, it suffers from both falling expected returns and rising correlations.  In other words, good trades get crowded and their advantages tend to disappear.  This crowding happens because success begets copycats as investors chase what has been hot.  Our behavioral biases all but demand it. 

Those of us who have been around long enough have seen this ongoing give-and-take happen time and time again.  Whether we’re talking about large-cap Dow stocks in the 60s (the “Nifty Fifty”), gold during the 70s, Japanese stocks in the 80s, U.S. stocks (especially techs) in the 90s, or more recently (for example), gold, commodities, bonds, China, private equity and Apple, to name but a few, the trend is your friend right up and until it isn’t anymore. Let’s take a quick look at one of these examples, currently in the news, and examine the consequences of failing to recognize the crowding phenomenon and to adapt to the consequences thereof in a very specific context.

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