Lessons in Contrarian Investing: Don't Buy Because You Have To

The large rally over the last six months is beginning to have its desired effect. Investors sitting on the sidelines are now being forced into the stock market due to their fear of missing out on further upside.

Super contributions are going through the roof. The Australian Financial Review today reported that ‘official figures from the prudential regulator yesterday showed Australians invested $117.5 Billion in super in 2011-2012, the second biggest splash into retirement funds on record.’

Changes in government rules halving the amount that people over 50 can contribute to super was obviously one of the key reasons behind the leap in contributions before the rules changed, but there is also a sense that the rising stock market is lowering people’s guards and luring them back into equities.

We are all very aware of the multitude of problems out there, and the stock market has been ‘climbing a wall of worry’, but it now feels like the bears (like me) have retreated to their caves and are licking their wounds while the bulls are telling everyone who will listen that everything is fixed and the market will continue rallying.

Retail sales ‘unexpectedly’ dropped yesterday, falling 0.1% in November. That was the first decline in four months and took the annual gain to a paltry 2.9%. But the market happily ignored that.

Job vacancies are dropping like a stone. The total number of job vacancies in November 2012 was 166,800, down 6.9% from August 2012 according to the Australian Financial Review. Job vacancies in the private sector are at their lowest level since May 2010. But again the equity market shrugged its shoulders and marched on.

Volatility has crashed since the fiscal cliff negotiations were settled with the VIX having one of its biggest falls on record, plumbing a 5 and a half year low of 13.2 recently. Complacency is rampant.

I read a great comment about contrarian investing that billionaire investor Howard Marks sent to his Oaktree clients. He said, ‘To be a successful contrarian, you have to be able to:

  • see what most people are doing,
  • understand what’s wrong about most people’s behaviour,
  • possess a strong sense for intrinsic value, which most people ignore at the extremes,
  • resist the psychological pressures that make most people err, and thus
  • buy when most people are selling and sell when most people are buying.

‘And one other thing: you have to be willing to look wrong for a while. If the herd is doing the wrong thing, and if you’re capable of seeing that and doing the opposite, it’s still highly unlikely that the wisdom of what you do will become apparent immediately. Usually the crowd’s irrational euphoria will continue to take prices higher for a while – possibly a long while – or its excessive negativism will continue to take prices lower. The contrarian will appear wrong, and the fact that his error comes in acting differently from most people will make him look like nothing but an oddball loser.

‘Thus, in addition to the five requirements listed above, successful contrarianism requires the ability to stick with losing positions that, as David Swensen has written, ‘frequently appear downright imprudent in the eyes of conventional wisdom.’

‘If you can’t stand living with the embarrassment of being unconventional and wrong, contrarianism may not be for you. Rather than trying to do the difficult opposite of what the crowd is doing, you might have to settle for merely refusing to join in its errors. That would be a very good thing. But even that is not easy.’

I have to admit that being a bear in the face of a market that has risen 20% since June 2012 can sometimes make one feel like an ‘oddball loser’ but the fact remains that the rising stock market is a function of government and central bank policy, rather than a reflection of underlying fundamentals.

As Howard says later in his memo, ‘These people aren’t buying because they want to, but because they feel they have to. In the past I’ve referred to them as “handcuff volunteers.”

‘The normal response of investors to uncertain times is to say, “Because of the risks that are present, I’m going to shy away from risky investments and stick with a very safe portfolio.” Such views would tend to depress prices of risky assets. But, thanks to the actions of the world’s central banks to keep rates near zero, that very safe portfolio – especially in the credit markets – will produce little if any return today.

‘I find it remarkable that the average high yield bond offers only about 6% today. Daily I see my partner Sheldon Stone selling callable bonds at prices of 110 and 115 because their yields to call or yields to worst start with numbers – “handles” – of 3 or 4 per cent. The yields are down to those levels because of strong demand for short paper with prospective returns in that range. I’ve never seen anything like it.’

This is a very successful investor with many years’ experience in the markets saying that the current situation is unprecedented. We should all sit up and take notice of such comments. It is far too easy to become complacent about the state of markets and assume that prices reflect the true state of play.

As I mentioned yesterday in my article on the Yen carry trade, there is a very high correlation between the movements in the Euro/Yen, AUD/Yen and our stock market. The promise by new PM Shinzo Abe to print enough money to push their inflation rate to 2% should be seen as the real catalyst for the current rally. The fiscal cliff relief rally has played its part, but a chart of the AUD/Yen vs the ASX 200 that I showed yesterday is a reminder that our equity market is responding to world-wide money printing and little else.

AUD/Yen vs ASX 200

Click here to enlarge


The psychology of the market is always a direct function of prices. If markets have rallied for a few months, every news article you read is bullish, and vice versa. People will forever buy at the high and sell at the low because that is just how we are wired.

As a bear I now have no short positions at all in any of my portfolios. The bears have capitulated and people are now getting long this market.

As Howard said above, the contrarian will be made to look the fool before he is proven right. But ultimately my view remains the same; underlying fundamentals are deteriorating and the current rally is nothing but hot air luring the final few who have remained on the sidelines into the market at just the wrong moment.


Murray Dawes
Editor, Slipstream Trader

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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