When to be a Contrarian Investor
Paul Fain, CFP®
As an investor, do you follow the crowd or march to your own beat?
If more the latter, you might be a contrarian: “A person who opposes or rejects popular opinion.” When is it appropriate to be a contrarian investor? When markets are experiencing extreme highs or lows.
Warren Buffett warned, “Be fearful when others are greedy, and greedy when others are fearful.” In other words, contrarians do the opposite of the crowd.
History is replete with contrarian opportunities: the dot-com bubble of 1999 or the real estate bubble of 2007. Buffett also said, “You pay a very high price in the stock market for a cheery consensus.”
Does contrarian investing work? Sometimes. Consider Morningstar’s annual “Buy the Unloved” study. The research firm has found that, generally, the most unloved investment categories (those with the most outflows in the previous year) tend to outperform the loved categories (categories with the most inflows) in the following year. Science? Hardly. But an interesting phenomenon based on investments that are over-bought or over-sold.
Another example is the assertion that consumer confidence is inversely related to stock performance. The data is supportive – when investors are deeply concerned, stocks are likely to rise. “A contented populace, on the other hand, is the equivalent of red sky at morning (take warning),” writes John Rekenthaler, Director of Research for Morningstar Research Services LLC.
Consumer sentiment now hovers near its 35-year low. “Glum times are not much fun” Rekenthaler adds. “There is, however, a silver lining for equity investors, in that such moods have typically presaged strong stock market gains.”
What’s next? Patience. Think twice about chasing the most popular investments. When an investment or market takes a nosedive, do not buy immediately. Find out what is going on – is the drop in price(s) justified? For example, it may be early to bet on a turnaround in the commercial real estate market. However, your research may reveal beaten-down investments or markets that may be due for a rebound sooner than later.
After an abysmal 2022, bonds are rallying. Longer term, data is pointing toward opportunities in international and value stocks.
Right now, there are few extreme market highs or lows but many markets are trending higher. Consumer sentiment is trending higher. So? Prepare yourself for the next downturn. Baron Rothschild, an 18th-century British nobleman and member of the Rothschild banking family, is credited with saying that “the time to buy is when there’s blood in the streets.”
Finally, contrarian investing is not a portfolio management strategy. It might simply be a tactical overlay at the fringes of your investment decision-making process. Diversification and risk management are still critical matters.
This article originally appeared in the Knoxville News Sentinel on July 29, 2023.
