You Can Learn Where To Invest From Hollywood, Hedge Funds and Billionaires

Ever since Adam Smith wrote Wealth of Nations, we’ve known the first rule of unfettered economics -- supply and demand balance each other.
The second rule is that money moves on.
There are numerous interesting examples of this at work right now. Knowing where money is flowing might help you make some slightly different investment decisions. It also makes some mysteries clear.
Last Thursday, in IDE, for instance, I’d found an interesting study of dollar strength and stock market returns to share with you. That London Business School/ABN Amro study found that the stock markets of strong currency countries tended to do worse than the markets of countries with weak currencies.
It seems counterintuitive. Why would anyone want to invest in a hot market if every drachma, real, rupee, dinar, or whatever that you made would become less valuable the longer you owned them? The second rule explains why.
Money moves where it multiplies best. Judgment does not always go along. While certain investors are super-smart about where to go and what the full, long-term implications are, most money is simply hot money. It’s greedy, spontaneous and slightly irrational.
Need an example? I’ll bet you’ve got one right on the street where you live. Look at all the people around you who said “housing prices here are crazy, nobody could afford this on a normal salary” with one breath and “I bought a house with nothing down and I plan to resell it for a big profit,” with the next breath. Even as they knew the market had gone too far, they saw everyone else’s profits and couldn’t help themselves.
One of the effects of hot money has hit Hollywood. The Brazilian real is very strong right now. According to Bloomberg, the currency has gone up 83% against the dollar in four years. Given the study I showed you last week, you might think twice about investing in Brazil unless the prospect is very solid. But if you are a movie star…
Brazilian marketers are suddenly able to afford stars like Sarah Jessica Parker and Sylvester Stallone because they now come cheaper than their homegrown celebrities. The real is so strong against the dollar that the marketers can buy U.S. stars at lower prices than they have to pay their own.
Some think this is a sure sign that the real is not only overvalued, but ripe for a big fall.
But when you want to talk big hot, hot, hot money, look to the sovereign wealth funds. The International Monetary Fund (that’s the bank, not another wealth fund) believes that these country-owned investment funds control about $3 trillion at present and will rule over $12 trillion by 2012.
If they don’t do anything too stupid, is what I say. Professor Olivia Mitchell of Wharton says that many of these funds are developing big appetites for risk and have “virtually no clarity of objectives” or transparency. And ditto for many hedge funds.
A good example of how this hot money takes big risks is Abu Dhabi’s $7.5 billion investment in Citigroup this year, which has netted a 40% loss so far.
Most of these funds are secretive, so we have no idea how many put big bets down on mortgage-backed securities. In fact, I wouldn’t be surprised if much of the future ugliness that many expect to see among irresponsible banks will actually be elsewhere—in sovereign wealth funds.
But there’s no denying these big spenders know what’s hot. How do we non-billionaire’s get a clue?
For that, I turn to John Murphy… see the market commentary for an example.