Sat 22 Jul 2006
Just read this great quote from Inside the House of Money (p. 205):
We are playing a variant of the Greater Fool theory which should be called the Slower Fool theory. According to the Greater Fool Theory, investors buy things [at inflated prices] on the hope that they can find a greater fool to sell to.
Following the Slower Fool Theory, …my plan …is to be faster than the other fools holding [similar positions] and liquidate before the oncoming Armageddon devastates them… To the extent that everyone believes the crisis is sometime in the future and somebody else’s crisis, the game is viable.
Unfortunately, the future will arrive and …it will be a discontinuous leap for investors specifically and the economy generally into illiquidity, panic, and chaos. I suspect many people’s investment strategies are not much different from mine. Keep buying that paper even though it is no good [while preparing] to head for the safe harbor.
– Richard Dennis, New Perspectives Quarterly, Fall 1987
First off, it is a little wierd to be quoting a book that is quoting a publication that is over 20 years old. Once we get past that, there are some interesting points.
The Slower Fool Theory pretty much sums up the game that I believe that many discretionary hedge funds are playing right now… get in and out before the rest and you have your profit. Unfortunately, with too many people playing the game, you can have a situation where everyone rushes for the exit at the same time — when you step into illiquidity, panic, and chaos.
The market action of the last two months have definately not been that bad (the S&P is down 7%, the Nasdaq is down 17% since January). But if we have hedge funds try to sell to the slower fool… a lot of people running for the exits all at once… as we see highly leveraged positions unwind… as we see the Bank of Japan starting to raise rates and consequently the cost of the carry trade… we could be in store for some serious fireworks.