The Dangers of Being Trendy
It's natural since we don't know what the future holds to believe that current trends will persist. In investing, this can be a costly habit. Hot products tend to fade rapidly and cold products spring to life just when we've given up hope.
In the last few years it's easy to point to some areas where people were clamoring to participate right before the end. Early in the summer, everyone knew that they wanted to have commodities exposure in their portfolio. They knew that they wanted to own gold because it was going to keep going up. They had to own oil after it had gone from $20 a barrel to $150.
Then what happened? Oil had a record drop, declining 60 percent in a short time. Most commodities, including gold, cratered.The fever pitch was extinguished overnight and these commodities were left for dead. Does that mean they will never come back? Certainly not. Could they recover in the next few months? Possibly. Does anyone know for sure? Absolutely not.
Another good example is the dollar. For five years, the dollar declined compared to most major currencies. Against the Euro, the dollar lost nearly half its value. Everyone knew that the dollar would continue to decline for years. Then what happened? In a few months the dollar rallied more than 20 percent versus the Euro and everyone stopped talking about it.
More impressive still was the private equity bubble. In private equity, investors have formed giant funds to acquire public companies or pieces of companies that they think are undervalued. The private equity investors generally attempt to refinance and improve the business and then resell it in a few years at a significantly higher price.
As with other trends, this started with some good ideas. Under-performing businesses or parts of businesses often gained a new focus and performed better under new management. Sometimes hidden assets were highlighted.
However, as with other trends, this simply went too far. Too much money poured into the area and the pressure to make gigantic multi-billion dollar deals overcame the ability to find good ones. Competitive pressure drove up the prices and introduced too much risk and debt into the transactions.
Private equity deals became so pervasive that they propped up the entire stock market until debt financing started to become scarce in June 2007.
Nothing better highlights the quick spike and demise of the private equity bubble than the case of General Electric. The trend had gotten so absurd that in June 2007 the Wall Street Journal ran an article talking about how much more General Electric would be worth in a transaction than it was currently selling for in the stock market. At the time, G.E. was the most highly valued company in the world.Fortunes fell so fast than in September 2008 in the midst of the financial crisis, G.E. raised $12 billion in a stock sale to bolster its financial businesses.
All this came to our attention again today when Blackstone, the world's largest private equity firm, posted a loss of $500 million, only 18 months after it became a public company.
On Wall Street, all trends hold peril and its wise to keep to sound investment principles and not get carried away the latest great fad.