croton blog for croton-on-hudson new york


Follow the Herd?

June 14, 2005

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"Cause when life looks like easy street, there is danger at your door” -- Jerry Garcia/Robert Hunter, “Uncle John’s Band”, 12/31/69.

There has always been a pervasive investor behavior on Wall Street to “follow the herd”. By doing so, if you were right you made piles of cash and looked like a genius. If you were wrong you weren’t the only one to go down with the ship so it was explainable and you kept your job. However, in the last few years this phenomenon has reached a fever pitch dangerously in lock step with our society’s new found access to any and all information, most of which people never take the time to fully understand.

In the 90s it was tech stocks, mutual funds, and 401Ks. Remember that? It was all the talk to brag about which hot tech fund you just found out about or how much you were earning on your 401K (even though you couldn’t touch it for 30 years!!). We all know how the 90s ended – with the biggest financial bubble of all time bursting. What a flawed investment strategy – being long stocks all the time – but more on that some other time.

Now we have a dual hot fight between hedge funds and real estate. If I hear one more time about my sister’s friend or my neighbor’s cousin making money by “flipping” real estate I think I’ll….. ! Last time I checked real estate was an immovable slow-developing asset; why all of the sudden is it on Time magazine’s latest cover and featured every day on CNBC or CNN? The answer is the get rich quick mentality that pervaded the 90s has not left us.

Speculation is king. Buy now, ask questions later. Get in on it now because if you don’t someone else will. This sense of instant gratification has ingrained itself in the American psyche and won’t leave. It is unrealistic. Constant exploitation of things – anything from financial assets to movies to sports to reality shows to books to websites to clothes to cars to cable news programs – eventually drives down the quality and therefore the economic benefit of that thing. It is inevitable, the law of diminishing returns.

Then there is the proliferation of hedge funds that seems to continue unabated despite recent troubles with GM that has roiled some of the biggest hedge funds in the world and generated lots of bad press. The hedge fund market is almost as hot as the real estate market, except the actual returns have been poor (more on this later). Today we stand with more than 8,000 hedge funds in the world and 3,000 or so more expected to start-up in the next 5 years. 8,000 of something sounds like a lot doesn’t it? That sounds like something awfully crowded to me.

My microeconomics 101 text book used to say that the more players that entered an industry, the lower the subsequent expected return. I guess all of the newer hedge fund managers I see were either too hung-over or too busy day trading NASDAQ stocks to come to that lecture in biz school. But like the rest of America, what you don’t know won’t hurt you, right?

Usually by the time “everyone” is talking about something it is the top or near top. Please remember that. For every new buyer of something there is a seller who has just made his own ton of money. Caveat emptor.

Whatever happened to nuts and bolts investing? What ever happened to investors doing their homework, and better yet knowing what homework even needed to be done? Too many people want something for nothing in this world, and Wall Street is certainly no exception. I have found, more often than not, that being on the other side of conventional wisdom has been the most profitable place to be. Go with your gut, not the herd. If something sounds too easy, it usually is!



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