Don't believe the hype

Signs of the coming hedge-fund apocalypse.. So says Daniel Gross.

Excerpt:



Those same signs suggest that our next bubble is already here, and it's … hedge funds.

Let's review the classic warning signs:

1) Public investors are getting really excited when insiders sell, believing they're being cut in on a great deal.

2) Everybody and their mother is getting into the business.

3) As the naive newbies are plunging in, the successful early adapters move on to the next big thing.

4) In the late stages, the investment craze crosses over into the broader consumer culture.

5) My portfolio is in turnaround.


#5 notwithstanding, these would ordinarily be very good warning signs. However, he's missing the elephant in the room. Derivatives. The rise of derivatives which was once the subject of a fear mongering report on 60 Minutes is now largely responsible for the mass stability seen in global markets. This IMF report spells out how that works. Essentially, the rise of credit market derivatives has spread that risk out so the fluctuations are not confined to one sector or region. Further, the risk is also diversified upward into the secondary risk market the "risk wholesalers" if you will. Even sovereign risk has been significantly mitigated in its wake. Much of the reason we're seeing less currency devaluations than we did in the 1980's is directly attributable to the rise of derivatives.

Mr. Gross is missing the forest for the trees and it would be cynical of me to say that he would do so to sell copies of his book.

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