Contrarian investing is not simple and it is not some kind of automatic road to riches involving brilliant market timing and scintillating asset selection. It requires a high level of discipline and the ability to gradually purchase the least popular assets while selling the trendiest ones. Much of the time you will be told on a daily basis by the mainstream financial media why you are doing the wrong thing and why those trends where the most investors have eagerly jumped aboard will continue indefinitely. My primary purpose is to point out patterns which are occurring now that in past decades have most consistently been followed by certain kinds of subsequent market behavior. Being a contrarian is not about finding a majority opinion and doing the opposite, but acting only when a majority has become a nearly unanimous consensus. If you are still interested, please read the more detailed description below. Thank you very much for considering True Contrarian.
Investing, like most other worthwhile pursuits, is inherently complicated. Some analysts and advisors attempt to remedy this situation by oversimplifying or by trying to focus too narrowly on certain concepts while losing track of the big picture. When I write my updates, each one is like an episode of a soap opera. If you watch just one random selection of a soap opera or a long-running series for the first time, it will be bewildering why Julia is angrily slapping Paul's face, or why Tricia is delighted about Michael's odd remark. However, over a period of months, you gradually get to understand the dynamics and how everything is interrelated with everything else. Nothing in the global economy happens in a vacuum; all assets are connected in ways which cannot be quickly explained in a few paragraphs. My objective will be to present you with a unified theory about what is happening, and I will let you know when certain facts don't seem to fit my hypotheses. The markets are always evolving, so keeping track of what is most important is a real challenge. I will try to always be honest and direct about my opinions and the logic behind them.
Being a contrarian investor is not about finding out what is the majority viewpoint and doing the opposite. That is how it is often portrayed, but like almost everything else in the mainstream financial media, there are distortions either from intentional bias or for other reasons. To be a successful investor requires monitoring the mood of the market, and how people are feeling at any given time. If people are becoming increasingly bullish toward any asset, such as the S&P 500, then it will likely continue to climb for an extended period of time. Eventually, if that asset begins to slow its ascent, and particularly if it has been struggling to reach previous highs while investors are becoming increasingly optimistic and confident, then that is when a reversal becomes more likely to occur. Reversals don't happen often, so it is important to be patient and to wait for a combination of signals to conclude that a trend has become exhausted and is likely to make a meaningful move the opposite way.
Thus, it is only worthwhile to be a contrarian when a given opinion has become so popular that it has become a nearly unanimous consensus. At any given time, there are likely to be relatively few assets which fit into this category, although this varies widely through the decades. Being a contrarian investor has a lot in common with being a value investor, since one important step in formulating a coherent theory is being able to estimate fair value for anything. This is not simple: it can involve computing a typical ratio of prices to household incomes for real estate, and it can incorporate price-earnings ratios for stocks. However, these can also be misleading when taken in isolation, and they don't necessarily tell you what will happen next. This is one reason that I study a variety of information which I believe to be important and which is not usually tracked carefully by most of those who participate in the financial markets. The commitments of traders, the degree of insider buying and selling in any industry, investor inflows and outflows, media and investor sentiment, and divergences between assets often send useful clues especially when these and other signals are considered in combination.
Nothing is certain about the financial markets, and I am always suspicious of those who confidently state price or time targets for anything. There is never any way to know how extreme anything will become in either direction, and with the invention of the internet it has become so easy to trade most securities that herd behavior can often cause astonishing highs and lows. Even for illiquid assets like real estate and collectibles, the past two decades have experienced unprecedented fluctuations in both directions. This situation is not likely to change any time soon. It is therefore necessary to keep track of how people are behaving emotionally under any given set of circumstances. While fair value can be estimated with some kind of educated guess, over relatively short time periods the financial markets are primarily driven by psychology. People often buy specific stocks not because they have carefully analyzed their long-term profit potential, but because people they know are bragging about how much money they're making by owning them. People often sell a security not because it is compelling to do so, but because it has been in an extended bear market with repeatedly negative media commentary, and people can't envision that a strong rebound is possible.
There is also a proven tendency for investors to be eager to own whatever has recently been enjoying the smoothest uptrends, while selling whatever has been moving up and down with dramatic percentage moves and overall recent losses. People instinctively like calm and what appears to be predictability, while shying away from whatever seems unreliable and risky. The catch, of course, is that the best bargains almost always behave in a way which makes them seem to be too dangerous, while the most overpriced assets with the greatest risk of loss will often behave in a deceptively placid manner. For example, when the S&P 500 was below 900 in its previous bottoming cycle, it experienced wild gyrations which discouraged almost everyone from buying it when it was most worthwhile. Once the S&P 500 had more than doubled and was close to two thousand, it experienced an extended calm period where many eagerly flooded into index funds based upon it. Academic studies have shown that investors repeatedly buy high and sell low, and don't even realize why they are following this pattern. You can be pretty sure that the next time the S&P 500 or anything else is really worth buying, people will be afraid to do so because of the way it will act on a daily or weekly basis, and because almost everything they read in the media will be warning them to stay away.
My updates will consist of several different kinds of analysis. Each week, I will report on the traders' commitments and which ones are giving the most important warnings of likely price behavior. I will sometimes include charts, but not for the reason that you will often see charts included in an analysis. I don't believe that the past activity of any asset by itself will be able to forecast what it will do in the future. Instead, a chart is an excellent way to examine how anything has behaved over an extended period of time. When this information is combined with patterns which have proven themselves repeatedly through the decades, a coherent picture can begin to be formed.
In other updates, I will discuss some aspect of behavioral analysis, emphasizing the kinds of human behavior which are likely to occur even though they may be irrational. Since we are human, we do everything as humans do, including investing. We don't behave like the dispassionate Vulcan "Mr. Spock" on Star Trek. If we did, then the best investors would be those who are able to most accurately forecast future profit growth and strict fundamental information. Being a successful long-term investor begins with the fundamentals, but also examines in detail how many groups of traders and investors are behaving for reasons which have nothing to do with rational thinking. For example, many investors are obsessed with how much money they are making or losing on any given trade and will make decisions to close out their trades based upon this information rather than whether it is actually timely to be buying or selling. Many will buy out of excitement or sell out of disappointment. Therefore, the collective behavior of investors will rarely track fair value and will often end up with the most confident buying near a top and the most despondent selling near a bottom.
There are numerous other topics which I will cover periodically. Brokers often have ways in which you can trade commission-free, although they are not always advertised. More investors have learned about exchange-traded funds in recent years, but many fail to take advantage of one of their most worthwhile features which is the ability to create ladders of orders to gradually buy or sell them. Even fewer investors are familiar with closed-end funds which can trade above or below their net asset value, which thereby provide buying opportunities whenever their discounts are unusually above their average levels and good chances to sell when these discounts narrow or disappear entirely--or they even trade at a premium above net asset value. It is occasionally advantageous to take advantage of opportunities outside of regular trading hours. There are often funds with low management fees which aren't as well known as nearly identical funds with higher fees. I also discuss real estate and its role in your portfolio. Some analysts overlook major asset classes such as U.S. Treasuries and other kinds of bonds which cyclically provide the most compelling opportunities with relatively lower risk and higher dividends.
The media often give very useful clues to making trading decisions, but not because they accurately tell you when to act. Instead, they tend to become convinced as a group that a particular theory is correct whenever it is most likely to be proven to be the end of a trend. If you scan any major web site about the financial markets, there will sometimes be disagreement about the future behavior of a given asset. When that happens, it is usually best to do nothing. When everyone is certain that interest rates will continue falling, or that the U.S. dollar will keep going higher, or that the U.S. stock market will extend its recent sharp correction or surge, and nearly identical sentiment is repeated on dozens of web sites, then that is when it becomes most likely that being a contrarian will be worthwhile.
The value of doing nothing is underestimated. Many people believe they are only accomplishing something as an investor when they are actively buying or selling. Most of the time, it is best to watch rather than to trade. I call this "being a proud couch potato" since it is usually derided. The thinking is that real traders don't just sit there; they do something. Buying or selling when you should be doing nothing can be harmful. If there isn't anything compelling, then you shouldn't look for the best of a bad lot.
Many people tend to believe that investing success is all about brilliant stock selection and magical market timing. In my opinion, a disciplined approach to asset allocation is far more important. No one can know which company will be the next industry leader, or what the financial markets will do next week. If someone pretends to know, run as far away from that person as you can. What you can do is to gradually accumulate whatever is least popular and for which there are historically reliable signals telling you that it is likely to move higher, while gradually selling whatever is trendiest especially whenever there have been increasing negative divergences.
Another useful example would be the behavior of the Russell 2000 versus the S&P 500. You can track the Russell 2000 using the fund IWM, while SPY represents the S&P 500. From early March 2009 through early March 2014, which was five years, the Russell 2000 gained roughly 4 dollars for each 3-dollar rise in the S&P 500. Then, starting in the first week of March 2014, the Russell 2000 began to underperform. The Russell 2000 consists of companies 1001 through 3000 by U.S. market capitalization, while the S&P 500 represents companies 1 through 500. For more than a century, U.S. equity bear markets have begun with smaller U.S. companies more consistently struggling relative to their large-cap counterparts. You can observe such behavior in past years including 1929, 1937, 1972, 2007, and 2015, and yet very few act upon this information in a meaningful way. The more that you understand which divergences in the financial markets are the most important, the more you will be able to have some useful guidance in making essential and gradual asset reallocations. Below is a long-term chart of IWM which tracks the Russell 2000, and below that, a chart of the S&P 500 so you can see this interrelationship visually.
Here is the Russell 2000, which had been outperforming the S&P 500 for five years until it began to underperform in the first week of March 2014 and rose to a modestly higher all-time top in June 2015:
Below is the S&P 500, which due primarily to relatively few well-known securities had continued to enjoy meaningful gains through May 2015. Such a divergence between these two, which had previously occurred in 2006-2007, is usually followed by a choppy, extended bear market for both:
While I take investing seriously, I like to feature some humor in my updates. The world is often a more livable place when we are able to laugh, especially at ourselves. I have certainly made more than my share of ridiculous mistakes in my trading. The world is interesting because the future is always unknown, and even in hindsight we can't always understand why events transpired as they did. Past patterns tend to repeat themselves, but usually with variations which are inherently unpredictable. I am not going to pretend that I had forecast any of numerous bubbles in recent decades, or whatever is the opposite of a bubble for some sectors which had collapsed in amazing fashion. At all times, I make my best effort to adjust most intelligently to whatever has occurred, knowing that there will be plenty of new surprises ahead.
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