Grouping the investment themes – a mental short cut

Grouping investment themes together is a mental short cut many investors take. We have seen many examples of such groups, e.g. Asian tigers, emerging markets, frontier markets, mid-cap stocks, suburban real estate, condos, precious metals, infrastructure stocks, BRIC countries, ICE stocks, unicorns (start-ups), e-com start ups – the examples galore.

In the process, all the individual investments are considered to be equally safe. In search of opportunities, investors often forget that the risks could be vastly different. Almost invariably, they land up with the investment options that appear to be “safe” only because these belong to a certain group or a club.

The truth is discovered much later.

By the time the realisation happens, many have highly concentrated portfolios with poor liquidity and high leverage – a lethal combination.

#RidingTheRollerCoaster – 178

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The seeds of the crash are planted in times of the boom and vice versa

The proximate causes of these successive crisis are very different – emerging market debt problems, the new economy bubble, default on asset-backed securities, the political strains within Eurozone – yet the basic mechanism of all these crises is the same. They originate in some genuine change in the economic environment: the success of emerging economies, the development of the internet, innovation in financial instruments, the adoption of a common currency across Europe. Early spotters of these trends make profits. A herd mentality among traders attracts more and more people and money into the asset class concerned. Asset misplacing becomes acute, but prices are going up and traders are mostly making money.  …

… Yet reality cannot be deferred forever. the misplacing is corrected, leaving investors and institutions with large losses. Central banks and governments intervene, to protect the financial sector and to minimise the damage done to the non-financial economy. that cash and liquidity then provide the fuel for the next crisis in some different area of activity. successive crises have tended to be of increasing severity.

The above paragraphs have been taken from John Kay’s book “Other People’s Money – Masters of the Universe os Servants of the People”.

Different market cycles appear different, but there is a lot of similarity in each. I have written about the anatomy of a market cycle in the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget” that echoes the above words to a great extent. If you observe, the parallels are often staring you in the eye. However, very often, we choose to ignore the signals.

The seeds of the crash are planted in times of the boom and vice versa. As Lord Krishna tells Arjun in the Bhagvad Geeta

Bhagvad geeta 2-27

#RidingTheRollerCoaster – 174