Value Investing And The Art of Being a Contrarian

"Two roads diverged in a wood, and I took the one less traveled by. And that has made all the difference." (Robert Frost)

Behaving like a good Christian is paramount for a deep value investor. Because many Christian values resemble core values and believes in his philosophy to investing.

Behave like a good Christian on the stock market. Take when everyone else is giving. And give when everyone else is taking" (André Kostolany)

The deep value investor knows by instinct that he has to take when everyone else is giving. And he has to give when his fellow investors are taking. It is crucial for a deep value investor to be well aware of the fact that one aspect of successfully implementing the strategy of deep value investing is the art of being a contrarian.

The Contrarian Mind Set

Humans have the tendency to think alike. Thus, in order to becoming a contrarian value investor one has to practice a little bit. Developing a habit of twisting the mind into directions which are opposite to the obvious.

"The art of contrary thinking may be stated simply: Thrust your thoughts out of the rut." (Humphrey B. Neill)

For the huge majority of investors it is almost impossible to part company with the "crowd". They seem to be unable to take when nearly everyone is fearful and things look bleakest. They are unable to give when the masses are euphoric and the economy appears strong.

But this is precisely what the true value investor has to do in order to produce superior returns on the long- run. The so called value investors that go along with the majority of its fellow value investors all of the time are doomed. They are doomed to keep with themselves. And thus, they are doomed to duplicate the mediocre performance of the majority.

The Nonconformists: Leaders And Innovators

A good anecdote when it comes to the art of contrary thinking is Getty. In 1962 he loaded up on stocks against the following headlines: "Black Monday Panic on Wall Street—Investors Lose Billions As Market Breaks—Nation Fears New 1929 Debacle". 

It is said that Getty commented to a puzzled correspondent: "I'd be foolish not to buy (...) Most seasoned investors are doubtless doing much the same thing (...)" And feeling like a schoolmaster conducting a crash course in the elementary principles of investment, he noted: "(...) They're snapping up the fine stock bargains available as a result of the emotionally inspired selling wave."

"Be a nonconformist when using your mind. Obvious thinking—or thinking the same way in which everyone else is thinking—commonly leads to wrong judgments and wrong conclusions.When everyone thinks alike, everyone is likely to be wrong." (Humphrey B. Neill)

The enterprising investor who wants to get rich in the stock market will find the field wide open. But only provided he is willing to part from the crowd, even if the crowd claims being value investors. He needs to head and act upon his creative imagination. Relying on his own abilities and judgment rather than conforming to patterns and practices established by fellow investors. Constantly Reading The Air and always being aware that it is the nonconformist who is the leader and originator.

Those are the investors who have an excellent chance to make a fortune in the business of value investing. They are the individuals that can wear a purple toga instead of a black suit. They can drink yak's milk rather than martinis. They drive a Beetle instead of a Porsche. They invest in deep value situations when everyone else is engaging in scuttlebutt and nifty fifty investing.

And none of it will make the slightest difference. Ability and achievement are bona fides no one dares to question, no matter how unconventional the person is who presents them.

The Intelligent Contrarian Investor

But always keep in mind that you want to become an intelligent contrarian investor. The basic idea of contrarian investing is that you should go against the majority. But this is an oversimplification of the contrarian strategy.

It is certainly not true in the middle of a bull or bear market. Because the majority of the crowd being bullish, and the minority being bearish and vice versa, is not a reason that the market cannot go higher or lower. In fact, it is rather the other way around. It is very likely that the market will advance or decline further, because the inflection points have not been reached yet. Especially, when overall valuation is still reasonable or remains extended.

The time to be wary of the crowd, and bet decisively against it, is when the crowd gets extraordinarily one-sided. All the other times you are better off following the "wisdom" of the crowd and/ or doing nothing.

Thus, flexibility is another trait that is indispensable when it comes to successfully implementing a contrarian value investing strategy. Turning your emotions inside out, contemplating the behavior of yourself and your fellow investors, and to act when you need to act, and make nothing when nothing has to be done.

Trading Volume: The Single Best Indicator Showing The Sentiment

The conventional wisdom is that the final turning point of a crash is accompanied by high turnover on the stock market. In my experience that is not to be witnessed when a real bear market is petering out.

A real bear market is a stock market that crashes more than 50% and staying at those depressed levels for an extended period of time. When the public is so disgusted of this spectacle that they do not watch anymore. That is when diversity in opinion has broken down and the crowd has become extraordinarily bearish.

"Succeeding on the stock market is all about figuring out if more idiots than stocks, or more stocks than idiots are circulating on the trading floor" (André Kostolany)

Almost no demand in a stock exists in such a situation. Volume is abysmal. The general public is loaded with cash. They are cash rich but asset poor, and not in a hurry to buy. The intelligent contrarian investor, on the other hand, is illiquid and not in a hurry to sell. In such a situation even a minor increase in demand will cause the share prices to rise significantly.

Similarly, when the general public becomes heavily bullish a dearth of demand exists. Demand is saturated, and even minor increases in supply will cause stock prices to tumble. At both inflection points, prices are a strong bet to move significantly!

There is evidence that a handful of investors do outperform the market over a long period of time. Academia is refusing that fact by claiming those investors are only lucky. I personally believe that a handful of investors exist that can produce superior outcomes on the long- run. Although luck is a contributing factor, I am convinced that unique personal traits those investors posess are more important.

But writing about the extraordinary contrarian opportunity in Japan, and nobody even willing to listen, more and more I come to the conclusion that the skill sets that are required to outperform the market on the long run are not easily, or even not at all, transferable.

Being an intelligent contrarian is one of those skill sets. If you cannot stand living with the embarrassment of being unconventional and lonely for an extended period of time, being a contrarian is surely nothing for you. You might have to settle for merely not joining the crowd's stupidities. Unfortunately, even that appears to be an impossibility for the majority of investors.

Source:

Ned Davis; THE TRIUMPH OF CONTRARIAN INVESTING: Crowds, Manias, and Beating the Market by Going Against the Grain; McGrawHill 2004

David L. Smith; THE CONTRARIAN MINDSET: Key to Investment Success; Cyclical Investing and The Cassandra Chronicles

Humphrey B. Neill; The Art of Contrary Thinking; Caxton Press; January 1, 1954

Howard Marks; Ditto: Memo to Oaktree Clients;  January 7, 2013

Tim Price; As Contrarian Investment Go; PFP Wealth Management;
28th April 2014