I recently had the privilege of attending an investment talk hosted by a private bank for their clients. The talk was given by a bunch of people with really impressive sounding titles and fancy accents, so it was a fascinating experience. Halfway through the talk, I came to realize that what they were describing, was basically the “Smart” Money trades of 2018, ie. the consensus trades of the year. There are 3 ways to look upon such Smart Money trades:
1. This is the “Smart” money, if they say this, it is definitely true. If you belong to this school of thought, you think that the fancy Chief Investment Officer who graduated from Wharton and has an MBA from Harvard is always right. With the wealth of information and years of experience at his disposal, if he tells you to “long tech”, you’d be a fool for not listening to him and going “long tech”. Because these guys are so smart, they have probably studied all there is to know about the “long tech” trade, and tech will definitely go up as a result.
2. This will go up, because everyone thinks this way. The slightly more cynical school of thought goes like this. I don’t really care what the fancy CIO says. But I care that all the fancy CIOs in the market think this way, and are convincing their clients to invest in this way.
John Maynard Keynes first described this with an analogy to a beauty contest (now known as the Keynesian beauty contest). The analogy goes like this. There is a contest to choose the six most attractive faces from a hundred photographs. Those who pick the most popular faces (ie. with the most number of votes) will win the prize. A naive strategy would be to pick the faces you find most appealing. A more sophisticated strategy might be to guess what other newspaper readers would find most appealing. An even more sophisticated strategy would be to guess what other readers would guess other readers to guess are the most attractive faces.
In this school of thought, it doesn’t matter whether the original call was right. What matters is that everyone thinks that “smart” money is going into this trade, and they try to frontrun the trade. As more people pile into the trade, it becomes more and more successful, and momentum traders start piling in, which fulfils the original call. With this analysis, the timing is key, because if you were the first few guys in you’d make a ton of money. If you were the last guy in, you’ll be the idiot holding the bag when it drops.
3. Since everybody thinks this way, the gains have already been priced in. The final school of thought goes this way. The smartest money are the closed hedge funds, the sovereign wealth funds (debatable I know, but bear with me), the boutique money managers. The next level will the mutual funds, unit trusts, mainstream hedge funds, the pension funds. By the time it filters down to private banking, retail investors, most of the gains would already have been priced in. In a way it’s similar to School 2, but it differs in the timing, as this school of thought assumes that by the time we hear about it, there are no longer any gains to be made. It assumes that the only reason why we know about this trade is because the big boys no longer have capital to deploy into this trade, and they would like for the rest of the market to start piling in to boost returns.
So which is right?
I won’t profess to know which school of thought is the right one. As always, much will depend on the analyst, the bank, and the call in question. If I were to venture a guess, I would mostly rule out School 1. Predicting market trends with a high degree of certainty is more often than not a fool’s errand, regardless of whether you have an MBA from Harvard or not. Financial markets are a second order chaos system, where the system itself responds to prediction. To illustrate, imagine that a finance professor comes up with an algorithm that accurately explains every single price movement for the past 100 years. When used to extrapolate forward, this algorithm says that the S&P would be up 10% in 5 months. But because everybody now knows about this prediction, they instantly buy up the S&P, and it goes up by 10% tomorrow. Where would the S&P be in 5 months? Nobody knows anymore, because the system has itself responded to predictions about its movement.
There will definitely be exceptions like Warren Buffett who are able to get investment calls right more often than not, but even Buffett prefers to bet on broad, long term trends, with a holding period of many decades.
So that leaves Schools 2 and 3. Both have a similar fundamental underpinning, but School 3 adopts a darker view towards human nature, as it brings in the idea that more sophisticated players intentionally manipulate the less sophisticated players to achieve their goal. To use the Keynesian Beauty Contest analogy, it would be akin to a few particularly unscrupulous readers grouping up and trying to convince the more naïve readers to vote in a certain way.
“Smart” money trades of 2018
After all that talk, I won’t hold out any longer. Here are the “smart” money trades that Financial Horse distilled from the talk I went to. Which School of Thought do you fall into? Let me know in the comments below!
- “Digital Disruption” – Focus on Big Data harnessers and enablers, as well as anticipated value creation from digital commerce, digital payments, video games, cloud computing, artificial intelligence and cybersecurity.
- “Long US Technology and Financials” – Attractive opportunities in the US financial and technology sectors, led by US share buybacks due to repatriation of offshore cash.
- “Long China” – China’s economy is ultimately domestically oriented, and the growth remains resilient.
- “Long EM bonds” – Rising interest rates and volatility mean there is room to outperform in fixed income through a carefully curated portfolio, with special emphasis on Eurozone CoCo debt, blue chip Chinese credit, and Mexican sovereign debt.
The Weekly Horse
All Financial Horse does in his free time during the week is read financial news. With this new initiative (“The Weekly Horse”), hopefully some good can come out of it. During the week, I post articles that I enjoyed on the Facebook Group (do join if you want a sneak peak), and every Sunday I will collate the links for readers. I also take the opportunity to address queries from readers, or share any thoughts that I have for the week. If you enjoyed this post, do share your thoughts in the comments below!
Shared by a reader
When most people say they want to be a millionaire, what they really mean is “I want to spend a million dollars,” which is literally the opposite of being a millionaire. This is especially true for young people.
The secret to financial success is not complicated, but many people are not prepared to put in the effort to get there. It’s easier to believe that a new investment product with 10% returns will help you achieve your retirement goals, than it is to reduce spending to save up more.
The future of apple… is India? Good read nonetheless.
Shared by a reader
Seems like another reason for the banks to raise interest rates to businesses and consumers. Rise in funding cost. Going is their traditional cheap source of retail deposits? That also explains the many different types of retail deposits marketed by the banks nowadays. Even so, since beginning of the year to June, except for ocbc, the other 2 banks dbs and uob actually saw their sgd customer deposit base dropped ( both has abt 40-43% of their deposit in SGD. Ocbc has only 35% in SGD).
To maintain/grow their net interest income and net interest margin, which is the bulk of their total income (65-66% for dbs/uob and 60% ocbc, rest from fee, trading etc). banks have to increase interest rates to businesses and individuals faster than the increase in the funding cost, same time without destroying volume/demand for loans. . So far in their first half of year reporting, all the 3 banks have registered growth in the 2 matrices (sgd loans is a significant share). With now the rising cost of funding, together with the current environment of property cooling measure and potential trade wars impacting business confidence, can they continue this loan growth momentum? Noted in Hong kong, Ocbc actually sees its NIM squeezed because “the rise in cost of funding due to HIBOR did not result in proportionate increase in prime rate” Is it due to competition? can this happen to their SGD loans? or like in Indonesia, due govt intervention “ it was difficult to increase asset yield due to increase in funding cost, especially with the authority advocating single digit lending rate” (quote from Philips securities). Something to watch for whether we are a net borrower ( Seeing even higher mortgages/loan rates on the way as banks look to re-price mortgages/loans?), or investors, especially of banking stocks…
Shared by a reader
There is no one-size-fits-all investment strategy or plan, but what Warren Buffett recommended in 2013 is a compelling alternative to complicated strategies, and it’s applicable whether you’re in the West or in Asia.
Would you accept 100 million dollars if it meant that everyone knew about it? This guy thinks you shouldn’t. Interesting read that continues from last week’s theme that money isn’t everything.
I usually try not to comment on day to day market fluctuations, but today’s crisis in the Turkish Lira is looking a bit like the latest EM currency casualty in this rate hike cycle.
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