Trend following

Jeremy Siegel does not like trend followers

Finance professor Jeremy Siegel believes emerging market stocks have been in a bubble fueled in part by skyrocketing commodities prices, since many emerging economies supply the world with metals, fuels and other commodities. Also, trend-following investors have plowed more and more money into emerging markets as they chased past results, bidding stock prices ever higher. "I don't like markets that just follow trends," he says. "They attract trend followers who disregard fundamentals, and they all end this way eventually." Foreign stocks in developed markets "were not in quite as much of a bubble, but there are trend followers there, too," he adds.

Most short-term stock players are trend followers

If, as argued last Monday, the efficient market theory does not always work, when markets get over-heated, another, not quite academic, theory comes into play. Even after most participants have recognised that the prices are too high, that they have gone up too fast, and that, therefore, there is an increasing possibility of a sharp correction, they go on buying. (Indeed, most short-term players are trend followers).

The hope is that they would still be able to exit at a profit, because a "greater fool" will come along to buy the shares at an even higher price! This does work so long as the trend continues, but the risk is that the greater fool may turn out to be yourself!

Warren Buffet is not a trend follower

Buffett said investors should focus on things that are important and knowable. One attendee asked Buffett and Munger a big-picture question involving currencies, interest rates and current account deficits.

I loved Buffett's answer and I think it helped illuminate some of the differences between his and Munger's approach (rooted in the old-school tradition of investing) and the more populous speculative arena: "We don't play big trends. That's a bit too macro for us," he said.

Buffett said, excluding agricultural products, they do see something of a bubble in metals (especially copper) and oil. He said, like most trends, the fundamentals drive it in the beginning. And what the wise man does at the beginning, the fool does at the end. As trends form and gather momentum, they attract a speculative element. Eventually, that element takes over, and then you are in the danger zone. "We are seeing that in the commodity area," Buffett opined.