Source: Aleph Blog


Here is a fascinating chart from David Merkel at Aleph Blog. The chart shows the sentiment cycle that arises due to performance chasing. That leads to crowded and, ultimately, unsuccessful trades.

As David observes:

When money is being thrown at a sub-asset class, like subprime RMBS in 2006-7, or manufactured housing ABS in 2000-1, the results are bad. The best results occur when few are lending, and only the best deals are getting done. But that means that few get those high returns. That is the nature of the markets.
The same applies to corporate bonds. It is wise to avoid the area of the market where issuance is well above average. When I was a corporate bond manager, I sold out my auto bonds, and my questionable telecom bonds, amidst much issuance. I had many brokers puzzle over why I would not buy their deals, even though they were cheap relative to their ratings.
The same applies to private equity. When a lot of money is being applied there, it is a time to avoid it. As it is now, private equity is throwing money at promising companies, many of which hold onto the money for safety purposes, because they don’t have place to invest it. That doesn’t sound promising for future returns.

Identifying new sectors to invest in is often lonely.

Originally published here

Category: Cycles, Investing

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2 Responses to “The Strategy Cycle”

  1. RW says:

    Harry Browne often expressed similar sentiments; e.g.,

    Efforts to understand and control the apparent randomness of financial events often follow a predictable pattern. Whether it’s trading systems, numerical projections, cycle theories, most rules of technical analyses, or whatever:

    1. Grain of Truth: A fantasy is usually founded on a principle that makes common sense as a generality – an observation about life or the investment markets that seems self evident when called to your attention.

    2. Over the Edge: This principle is then stretched beyond the limits of its usefulness. Instead of being a reminder it becomes a school of analyses.

    3. Scientific Posture: Mathematics and the name of science are invoked.

    4. Coronation: The fantasy becomes enthroned. The market pattern that now and then seems to hold true becomes a tenet of natural law – it simply happens too often to be coincidence.

    5. Sweet Superiority: Those who follow the system, advisor, etc. become the “elite”. No matter how many times the plan goes wrong, they must be better off than the poor boobs who are not “with it”.

    6. Dogma: In fact, there is never a need to acknowledge that something went wrong because:
    a. It really did work but was offset by factors that were stronger in this case.
    b. The system is perfect but people practice it imperfectly.
    c. This was the exception that proves the rule.
    d. It happened exactly as expected; you must have misunderstood the expectation.
    e. It was a clear cut, textbook example, of the principle working on an inverted basis.
    f. The result has been delayed, pressure is building, so the effect will be even more powerful when it comes.
    g. …

    NB: Pretty sure I got this from Browne’s book, Why the Best Laid Investment Plans Usually Go Wrong, but I may have paraphrased some; it was a long time ago, ca 1990.

  2. rd says:

    Now trading – the ultimate uncorrelated, high-growth potentialasset to maximize returns when the market rolls over a the top of the strategic cycle above. Hedge funds are sure to be all over this one. I assume that Blackstone will set up its own competing pool of assets soon – they could buy a team of their own assets – I hear the Clippers may be up for sale soon. Blackrock will probably try to bundle them into an ETF.