The law of Excess

“In financial markets, the law of excess applies. Prices tend to go to extremes, on both the upside and the downside, and investment bankers conform to the unwritten rule that every good idea must be driven into the ground like a tomato stake.” This timeless piece of wisdom from James Grant covers two points worth looking into. First of all, humans are not perfect. Second of all, humans are not perfect.

We have cycles because we seem to think you can never have too much of a good thing. When asset prices are high, the collective takes this as positive feedback and pushed them higher. The same goes for nadirs. When an efficiency or new idea hits the market, there can never be enough, until there is, of course. As J.P. Morgan is credited with saying, “prices will fluctuate.” There is no point in guessing the future, but at a certain point, a price gets so low that it would be hard to turn down a purchase despite it’s quality. The same goes for high-priced assets; at a certain point, it doesn’t matter how good the future looks, a 1000x P/E rarely seems like a good bet.

When it comes to flooding the market with a hot idea, a la the tech bubble, that is also dangerous. When competition becomes high and owning a website domain is all it takes to raise a few million in funding, there may be a problem. This is oft brought up in Benjamin Grahams work. The initial public offerings are something to watch. Where is capital flowing? and why? Because the financial markets work within the law of excess, it pays to pay attention.

 

Source: Money of the Mind

 

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