Photo: James Santiago. Source: Wikimedia
I used to work near a near a big park, where I could eat my lunch on nice days. There wasn’t much litter. Leftover food would be quickly devoured by the swarms of pigeons that hung out there. They would poke about, searching for random scraps that had been left behind. If anyone started to feed them, a large group of birds would assemble in front of them. Dozens of birds would fly over, attracted by the others. In fact, you didn’t even need to have food to gather a flock. All you had to do was swing your arm and pretend to throw some bread crumbs.
Investors can be like pigeons, racing from one fashion to the next, attracted by the presence of other investors. In the past few years we’ve seen them rush from energy stocks, with their promise of seemingly limitless profits due to fracking to FANG stocks – Facebook, Amazon, Netflix, and Google, the mobile social, retail, and entertainment behemoths that are transforming everyday life. These stock prices seem to defy gravity, rising to levels seemingly disconnected from their ability to generate profits.
But a funny thing happens in the marketplace. Whenever an industry becomes popular, entrepreneurs take note. They move into that sector or business and increase the level of competition. What seemed a sure road to riches becomes a struggle that favors the most innovative producers. It seems like the law of gravity, but it’s actually the law of competition: excess profits invite new entrants that drive down prices. And the profits don’t disappear, but they aren’t so excess any more.
Ballistic flight illustration. Source: NASA
Information travels today at the speed of light. These themes start, grow, become over-inflated, and collapse in record time. Mutual funds used to have holding periods measured in years; now months or even weeks are more typical. Many quantitative investors who front-run order flow (to make a penny or two each trade) may own shares for only a fraction of a second. This trend—towards ever-higher turnover—doesn’t seem sustainable. But you can’t see a bubble from inside the bubble.
Long-term investors don’t need to play this game. We can look for quality businesses with a history of profitably serving customers with good products at fair prices and stick with those. We don’t need to fly off to the next new new thing. Just because the pigeons are gathering doesn’t mean there’s any food there. It may just be someone pretending to throw out crumbs.
Photo: Rajesh Mishra. Source: Publicdomainpictures. CC0,
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”