Even a genius can get suckered, by Thomas Levenson at CNN.
All, even geniuses, are susceptible to the “madness of crowds.” The fact that we rely on a systematic process to manage money doesn’t mean that we avoid all of the negative effects of bubbles. However, to us, the bubble is just a strong trend. We participate on the way up, never forecasting when the trend will end. After a reversal in the trend, our models rotate out of that area. This systematic process, though filled with periods of pain, has a well-documented history of leading to superior investment results over time.
There are ways to deal with the volatility experienced when trends end, such as mixing a trend-following strategy with a value strategy. The value strategy will likely pick up and perform very well when the trend-following strategy experiences underperformance. You can also maintain a minimum level of exposure to all asset classes (like we do with DWAFX), while overweighting the strongest asset classes. When the strongest of the trends reverse, the exposure to the other asset classes acts to buffer some of the volatility experienced at the turns.
Just in the past ten years, we have seen bubbles in technology stocks, real estate, and commodities. It is highly unlikely that the government is going to be able to regulate them away. Bubbles are here to stay. The question for investors is do they have an organized and logical way to capitalize on these bubbles?
