Friday, November 16, 2007

Fashion Belongs in Milan, Not in Your Portfolio

Have you noticed how certain investment strategies all of a sudden become must follow investment trends? A few years ago everyone was talking about how it is virtually impossible to lose money in the real estate market. Well, tell that to the folks who lost their shirts in the sub-prime meltdown. Now everyone is talking about what a smart idea it is to invest in emerging markets or commodities.

Every investment fashion is based on an attractive (but flawed) story. Back in the late nineties at the height of the dotcom bubble, everyone was talking about how there was this thing called the "new economy" and how old fashioned businesses were going to be replaced by all these shiny new companies that would sell us everything from pet food to medicine. I still remember my accounting professor in business school lamenting that the income statement has gone out of fashion since investors are now rewarding companies for losing money... well, they did. For a time. And then it all went to hell in a hand basket with the dotcom bust.

At its core, every bubble has a grain of economic truth. The Internet is really changing everything about business and drastic change is likely to continue in the future. However, that did not justify the crazy stock valuations of the late 90's. China really is going to become an economic superpower and will probably have a very important role to play in the 21st century, but that does not mean that it can sustain the crazy stock valuations and triple digit gains its markets have been showing. Real estate can really play an important role in your portfolio, but betting your financial well being on that one asset class? Well, that's just crazy.

The point I am trying to make is a simple one. If everyone is talking about a certain hot investment strategy, that is exactly the right time to stay out of that particular market. Fashion belongs in Paris, Milan and New-York. A fashionable portfolio is a losing portfolio.

At the same time, betting against these hot sectors is probably not a great idea either. Even if you are right and have spotted a bubble, the markets can remain irrational for longer than you can remain solvent. That's why I don't think that pursuing a short strategy, such as the one the Div Guy discusses in this post, makes a lot of sense. My suggestion, as always, is to stick to your indexes.


Fiscal Musings said...

Interesting commentary, but I do think there is money to be made in some of the asset classes you mention. Obviously the fundamentals should be followed and when things are too good to be true,...

The bottom line is to just be smart about what you're doing and don't just follow the herd blindly.

Shadox said...

I am not saying that there is no money to be made in those asset classes. In fact, I do believe that positions in real estate, emerging markets and so forth are good diversifiers that should be added to most portfolios. I am simply questioning the wisdom of getting into these asset classes with large positions, and in particular doing so when everybody else has done the same. This is simply performance chasing.

Armchair Fiduciary said...

So to turn your commentary on your head means you should buy things people hate right now. Perhaps a hombuilding or financials ETF? Have you given that any thought?
The only problem with this is whether or not the companies in these industries (for instance homebuilding) can stay solvent through all of this.