In Parts I and II, I presented readers with examples of obvious asset-bubbles – but in markets which were/are extremely manipulated. Given the obvious risks associated with “shorting� rigged-markets, I postulated that using (gold or silver) bullion as a “proxy� for shorting these asset-classes offered similar correlation to shorting these assets, but minus most of the risk.
That said, any time someone recommends to investors that a single asset-class can be held in lieu of various other investments, then obviously there will be concerns expressed with respect to the concept of “diversification�. Like much market dogma, “diversifying� one's portfolio is a classic example of an investment “sacred cow� – where financial advisors slavishly adhere to this “principle�, to the point of never even asking themselves why are they diversifying.
In this installment, I will take an explicit look at the concept of diversification, and explain to readers how and why this “Golden Rule� of investing has never been a more dubious investment principle.
To begin with, I will rhetorically ask “why are we supposed to diversify our portfolios?� The answer is simple: no one possesses a “crystal ball�, and thus no market participant can know what will happen in any given market, in the future. This premise is universally accepted without question in the world of investment, and yet I would argue it is strongly contradicted by vast amounts of recent, empirical evidence.
Regular readers will be familiar with the recent boasting by Wall Street Oligarchs that they “made money� every day in their market-trading, for an entire quarter. This data leads to only one of two possible conclusions. Either the most-profitable traders in U.S. markets did not “diversify� their own holdings, or the various asset-classes they held were so highly-correlated that they all performed in a near-identical manner (for an entire quarter).
It would simply be the most-remarkable fluke of luck (equivalent to winning the lottery) if an active-trader like Goldman Sachs could engage in true diversification, and still turn a profit every day. The fact that more than one Oligarch made similar boasts mathematically eliminates the possibility of this being purely a matter of luck.
In reality, as the operators of the rigged-casinos known as “U.S. equity markets�, Wall Street Oligarchs have been able to transform this collection of thousands of individual, corporate listings into a homogeneous force (farce?), where (depending on the slant attached to a particular company/sector) stocks all move up or down together. This has been accomplished through the use (abuse) of trading algorithms.
It was always inevitable that these market abominations would do exactly what they have done (create the near total-correlation of various equity/asset-classes). Despite this obvious reality,  even when these destructive devices caused a complete meltdown of U.S. equity markets – in a matter of seconds – all that ever occurred to brain-dead, U.S. regulators was to rig the markets even more extremely, since Wall Street Oligarchs would all rather surrender one of their own testicles, than their precious, market-rigging trading algorithms.
Thus, we have already shattered the myth of “diversification�, with respect to U.S. equity markets. Whether you hold one company, or one thousand (in traditional, “mainstream� investment sectors), there would be little overall difference in portfolio performance – unless the person holding only one company chose an exceptional under/over-achiever.
I would argue, however, that even if we eliminate the “correlation� caused by market-manipulation that we would/should also expect many other asset-classes to be highly correlated – especially when viewed through longer-term analysis.
About Jeff Nielson