A valuable trend or a knee-jerk reaction?
By
Tim Price Dec 18, 2007
Print this article
Perhaps the most frustrating thing about being an investor is the time lag between identifying what seems an obvious trend – positive or negative – and then waiting for the market to acknowledge that trend.
Sometimes, of course, the delay simply means the anticipated theme is incorrect. But in an unforgiving market, there is essentially no difference between calling a trend early, and simply being wrong.
This could be the case today for those of us who see growing evidence of economic slowdown, if not outright recession, on the back of the credit and interbank lending crisis. Despite all these fears, the equity markets, at least outside the financial sector, seem blithely indifferent to the gathering storm clouds.
The economist John Maynard Keynes articulated some of this frustration in his seminal work The General Theory of Employment, Interest and Money: “The game of professional investment is intolerably boring and overexacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll.”
Keynes also touched on stockmarkets’ gambling characteristics when he compared professional investing to judging a beauty contest. The winner, on Keynes’ terms, is not the judge who votes for the most beautiful woman; the winner is the one who correctly anticipates the choice of all the other judges.
This trend becomes increasingly cyclical (not to say short-termist), as the beauty contest judges continually attempt to second-guess each other. Welcome to the behavioural freak show that is the modern investment market.
The perils of short-termism are highlighted in Nassim Nicholas Taleb’s Fooled by Randomness: The hidden role of chance in life and the markets. Taleb uses the example of a (fictional) retired dentist who is guaranteed to earn 15% every year from his investments, with an annualised volatility of 10%. If Taleb’s dentist monitors his portfolio every second in real time – say, through an online brokerage account – there is only a 50.02% probability of his registering a gain, versus a 49.98% probability of him incurring a loss.
If Taleb’s dentist sounds fanciful, consider the thousands of traders throughout the world employed by investment banks and brokerage firms, each of whom is sitting in front of a Bloomberg screen and, erm, monitoring their portfolios every second in real time.
If this imaginary dentist cuts his portfolio monitoring to once a month, the chance of him seeing a gain shoots up to 67%; if to just once per quarter, it rises again, to 77%. Nothing whatsoever changes about his investment performance – only the frequency with which he checks it.
So it is not a great leap to suggest that a vast swathe of the investment industry (and a huge number of individual investors) is being lured into overtrading simply by market noise. They are reacting to inevitable variability in prices rather than to deep-seated trends.
Berkshire Hathaway’s Warren Buffett has also suggested a strategy for dealing with the challenges of longer-term investing. Imagine you have a punch card with 20 holes. Every time you make a new investment, you use up one of your 20 options. If you could only make 20 investment decisions in your life, would you spend more or less time assessing their merits? If your portfolio is scattered across multiple investments, which today would fail to make that 20-decision final cut?
Behaviouralists have shown that human beings are not hardwired to make decent long-term decisions. Instant gratification trumps long-term self-interest. But there is also plenty of evidence that disciplined contrarianism or simply sticking to your guns both win out over short-termist trend-hopping.
Which longer-term trends, then, might be worth considering? Iain Little and Bruce Albrecht of Global Thematic Investors have a few ideas: the rise of an emerging-market middle class; restructuring in Japan; inelasticity in commodities (both hard and soft); water shortages and ecology; energy and alternatives; and the development of China and global infrastructure.
These are long-term trends, lasting years – if not decades – helped by scarcity in underlying resources colliding with explosive demand. For suggestions of funds and individual securities that might best thrive within these themes, see www.moneyweek.com. The hard part, of course, is sticking with these trends – now over to you.
Tim Price is CIO of Global Strategies at Union Bancaire Privée, London. Tim also runs his own share-tipping service, The Price Report.
Published in
How to invest
| More
articles
by
Tim Price
Related articles
-
Nov 13, 2009
-
Nov 06, 2009
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.
