Fashions, Fowls, and Trend-Following

Where do investment fashions come from?

Photo: G Pinant. Source: Morguefile

I used to work near a large park, where I would take my lunch and eat outside. There wasn’t much litter in that park—any leftover food would quickly get devoured by the many pigeons that hung out there. They were always poking about, searching for random scraps that might have been left behind. If anyone began to feed them, a group would quickly assemble. First a few, then dozens of birds would fly over, attracted by the other birds. In fact, you didn’t even need to have food to gather a flock. All you needed to do was move your arm as if you were tossing out bread crumbs.

Investors can act like those 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 how we interact, shop, and entertain ourselves. Their stock prices seem to defy gravity, rising to levels seemingly disconnected from their ability to generate profits.

But a funny thing happens in markets. 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 way to print money becomes a struggle that favors the most innovative producer. 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—well, they don’t disappear, but they aren’t so excess any more.

Gravity illustration. Source: NASA

With information travelling so quickly, these themes get started, grow, become over-inflated, and collapse in record time. Mutual funds used to have holding periods measured in years; this is now months or even weeks. 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 it’s hard to see a bubble from inside.

Thankfully, 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 thing. Just because the pigeons are gathering doesn’t mean there’s any food there. It may just be someone waving his arms.

Douglas R. Tengdin, CFA

Chief Investment Officer

By | 2017-07-17T12:21:53+00:00 July 26th, 2016|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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