The S&P 500’s sharp decline and quick rebound in 2020 may mean that some investors think it's impossible to generate market-beating returns. They may feel that the stock market is unpredictable, and that they should settle for the returns provided by a tracker fund instead of taking a contrarian stance.
However, value investors such as Oaktree Capital co-founder Howard Marks (Trades, Portfolio) have consistently outperformed the stock market. In my view, Marks' ability to ignore the market consensus and focus on company fundamentals could be a key reason for his long-term investment success.
Outperforming the market
The unpredictability of the stock market’s performance over the short run can make outperforming the market seem like an impossible task.
For instance, few investors correctly predicted the S&P 500’s 34% decline in less than five weeks. Even fewer investors estimated that the market would surge 44% higher within 11 weeks between March and June.
However, predicting the stock market’s movements and outperforming it are two very different concepts. Investors can beat the market without being able to predict its future movements through adopting a long-term strategy that focuses on buying quality businesses when they trade at low prices.
As Marks once said, “Let others believe markets can never be beat. Abstention on the part of those who won’t venture in creates opportunities for those who will.”
Adopting a contrarian stance
Consistently outperforming the stock market requires a contrarian stance. Otherwise, your returns will mirror those of other investors and are unlikely to differ materially from those of the stock market.
There are many opportunities to adopt a contrarian stance at the moment. For instance, sectors such as energy and travel have been highly unpopular among most investors. Buying quality companies within those industries could lead to above-average returns in the long run as their operating environments gradually recover.
Going against the investing consensus can be a tough task. It requires self-discipline to ignore the views of your peers, particularly during volatile periods for the stock market. However, using company fundamentals to apportion your capital can be an effective means of taking advantage of the most attractive investing opportunities at a given time.
Marks has previously highlighted his preference for a contrarian investment strategy, saying,“You can’t do the same things others do and expect to outperform.”
Ignoring your gut instinct
Buying stocks when they offer their greatest potential rewards can be a tough task. Their low valuations are often prompted by challenging outlooks that could lead to disappointing financial performance in the short run.
Your gut instinct may be to avoid purchasing a company when it faces a tough period. This strategy may help you to avoid a volatile period, but could also mean that you miss out on its long-term growth potential.
As Marks once said, “Most people are driven by greed, fear, envy, and other emotions that render objectivity impossible and open the door for significant mistakes.”
Overcoming temporary losses
There are likely to be periods where your portfolio underperforms the stock market. For instance, buying stocks today may lead to paper losses due to the economy’s uncertain outlook. A weak economy could cause disappointing financial performances for some businesses that prompts a decline in their stock prices.
However, losses on stocks are not crystallized until they are sold. Therefore, investors with a long time horizon should not be concerned about them. They may even provide additional opportunities to buy quality businesses when they offer margins of safety.
As Marks once said, “The possibility of permanent loss is the risk I worry about.”
Read more here:
- Warren Buffett on Investing When Opportunities Are Scarce
- Mohnish Pabrai on Using Value Investing to Outperform the Market
- Peter Lynch on the Importance of Basic Investing Principles
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