Soros Financial Sector and Reflexivity
In the December 4,2008 New York Review of Books http://www.nybooks.com/articles/22113 George Soros discusses topics from his current book, The New Paradigm for Financial Markets, as well as his 1987, The Alchemy of Finance and his 1998 The Crisis of Global Capitalism. He argues that we, as participants in the market, occassionally affect the very market "fundamentals" that we use to determine when to buy and sell and that similarly to ourselves, government market regulators also have biased impacts that can affect the market fundamentals too. He calls this reflexivity. The extremity of the current market bubble, he argues (paraphrasing), was exaserbated by Alan Greenspan's desire to not be seen putting on the breaks for the economy, but that, had he done so, the bubble would not have grown so large nor the bursting been so catastrophic.
Sometimes it is hard to remember the lessons of the past. In reading about the Great Depression it strikes me that one of the biggest problems at the time leading up to the bust was the extensive access to and use of credit. People bought stock on margin in massive scale and were sunk when forced to sell at a loss. Sounds familiar - doesn't it? The impact was beyond that of irrational exuberance based on a short term market fluctuation. The market carried out an extreme correction and stock investing became unseemly in reputation, like gambling, by everyday Americans. But when I look back at that and I look at this current burst bubble, I realize that people, even through time, are the same as ever: we have an ability to know what is right and what is wrong, and to override that instinct in favor of what suits us here and now, even though we know that our choice is irrational and that it will have consequences that must eventually be dealt with.
One thing to take away from reading the current Soros material is that the financial sector should not be overweighted in our portfolios yet as it appears there are more shake ups coming. Also, because it is likely that the new government will insist on less extensive dependence on credit and on greater reserves in financial institutions, it is quite likely that banks, in particular, will be more difficult to profit from as their margins will shrink. The first time I read Peter Lynch's book, Beating the Street, Chapters twelve and thirteen, the chapters on Savings and Loans or basically, financial institutions and how they make a profit, I was struck by how tight the margins of these institutions are. They may have as little as a 1.5% difference between the resources expended to make money and the amount they actually bring in. If the margins are tightened by more stringent government regulation, then it may be more difficult to profit from financial sector institutions. However, the extreme opposite of that regulation, as we have seen, is not to be born.
Also, as a result of our regime change, we may have the next boom led by green sector technology and jobs. As a result I am studying companies like you might find in the portofio of Winslow Green Growth Fund (WGGFX) and its international equivalents.
The financial sector should be part of well rounded stock portfolios and I am not selling my financial holdings. But for less experienced investors, I would look elsewhere in the market for a little while longer.
I own some WGGFX.