Financial markets feature a phenomenon called “herding.” This is when investors mimic each other. Perhaps this is so because when times are bad, misery loves company. And when times are good, they can party.
The phenomenon upends one of the maxims of economics. Convention has it that the big guy can’t move without having prices move against him. When he buys, the market takes notice and the price rises; and of course when he sells, the price declines. For the big guy, it should be difficult to “buy low, and sell high.”
And yet, two of the biggest guys in investment are Warren Buffett, an individual investor, and PIMCO, an asset management company. They both have a very good record of performance. For them, the profits seem to come fast and easy, at least in my view.
Why is this?
When these two big guys move, they can’t hide, so they tell the world what they do. Buffett periodically reveals his portfolio choices. PIMCO, just today, made a prediction that the US dollar will fall (and presumably, if they believe what they say, they are net short the dollar).
Since other investors follow these two big guys, what they buy will subsequently go up, and what they sell will subsequently fall. When they decide to close out their positions, they will have made a nice profit, all because the lemmings do what they do.
Of course, they can’t make very weird choices. Their credibility to the herd would suffer. So long as there is a mildly credible story behind their portfolio picks, the game goes on.
It is also possible that Buffett or PIMCO will make wrong calls. But because of herding, their losses will be smaller than those of others.
Doesn’t that make you feel that life in the financial markets is very unfair?
I will update this post in about a week and month, to report on where the US dollar has gone. As of this writing, the dollar buys 94.343 yen, the Euro is worth $1.4108, and gold (100 oz FUTR) is quoted at $934.50 p.f.o.
Acknowledgment: This post was inspired by the ideas of Nassim Taleb. In effect, herding sets up a legal Ponzi that benefits Buffett and PIMCO.