The Contrarian Philosopher

They say good traders happen to be philosophers, and necessarily so. A good analyst must understand what everyone else knows. If a good play has been diluted with public interests, it’s not ought to be that promising. In June we wrote

Contrarians aren’t always right. Many times contrarians are dead wrong – consider shorting the market in 1998. Divergent thinking comes in handy only once fundamental analysis is strongly in play. A stock can be a good value, but if everyone is ranting about it, there may be something you don’t know.

As I read through some of the articles the bulls (as well as those who don’t want to write anything bearish) are writing, it seems that the spectrum has radically changed. One analyst writes that at times when short-interest is at record highs and shorting from floor Specialists are at lows, a bear market has never commenced. This fits with the chanting of all the short-term analysts who, along with all the technical technical analysis (yes), claim that markets remain stable and healthy. The problem with such thinking is that we find ourselves in an information age where the time difference between a headline, the trader wanting to make a trade and the trade being executed, is literally instantaneous. A short ratio can be cleared in a day or two through awfully volatile trading. The predicament may change during after-hour trading and may not even give the investor a chance to position him or herself properly. I mention this to bring up the dynamic concept of contrarian sentiment. Now, the average analyst, upon hearing this will probably roll his eyes. But in essence it is the core mindset; one indispensable to the long-term investor and his decisions. The idea is quite simple: Any great idea may cease to be a great idea if everyone knows it’s a great idea. An example is the “January Effect”. For years it was one of Wall Street’s biggest secrets: “Throw away the bad stocks toward year end as tax write offs and buy them back in January”. Naturally, year after year stocks rallied during this month, however over time as the average investor became aware, returns declined gradually to mediocrity. In the long run the crowd is always wrong. Yes, they may group together and seem equally successful over a period of time, but this will end badly, as did every bubble in history. This said, it becomes similiarly apparent that as the crowd begins to question the crowd itself, you are left with an inverse logic. This is what I believe is occurring in the markets as we speak; an increase in overall volatility as well as a wide spread of critical thoughts from both camps, (calls for both Dow 26,000 and 5,000). When people try thinking like contrarians, they flounder. They will often begin with a biased mindset, moving with ideas congruent with their desired outcome. This may be exemplified by the current logic of the bulls in two ways. Firstly, the “Stocks are long term vehicles and this is only short-term noise” group, remains dominantly strong. As a matter of fact I strongly believe that many astute investors haven’t sold a single share since markets have turned volatile. This will change and the longer it takes to do so the stronger and more crucial the downturn will be. Secondly, some analyst have attempted to claim themselves “counter-bearish” advocating how with so much worry in the air stocks will surely rise. When I look at the stock market I try time and again to see a rationale behind the presented logic. Just two weeks ago the Dow hit an all-time high. Unemployment stands at historically low levels, the economy seems stable and many have just been observant of the subprime mess. The Dollar hasn’t made any major adjustments, the Federal Reserve hasn’t touched interest rates (as they did in 87 and 91), many investors remain calm expecting the action to subside, the Dow hasn’t even reached what is considered an adequate Correction (10% decline), there is still the inventory problem in housing, there is still much speculation in the derivatives market as there are still many bond portfolios that have not yet been re-rated or marked-to-market. How could anyone say that the danger has passed? The contrarian knows to “buy when others are fearful”. When there are no more eager sellers, eager buyers are usually nearby. But where does one see frantic selling? Recent down days by no means represent liquidation, especially when a significant number of those days have been of strong rallies. It seems that now too, many who attempt to beat the market are indeed falling under their own weight. It has long been shown that the average investor wrongfully cuts his gains and extends his losses. In the event of a hard sell-off we may see again, as we have in recent days (and today), surging short-covering rallies. It is quite interesting to note that after every major crash in history a strong rally has followed. It happened in 1929. After October stocks began to climb again. Many investors eager to recuperate their losses, as well as throngs of people previously on the sidelines saw it as a buying opportunity. The market came back strong. Then along came the Crash of 1930 and wiped out investors a second time. This occurred time after time until 89% of investors money was history. Those “long-term” traders waited 24 years to see a positive return on their capital. “Be greedy when others are fearful and fearful when others are greedy” we are taught. And it sure as hell doesn’t seem like investors are running around in panic, desperate to sell shares for pennies on the dollar, at multiples of 10 times earnings, as they have in the past. We wait.


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