Contrarian investing can be a lonely experience. After all, it is never easy to be the odd one out while other investors are supremely upbeat in a bull market. Likewise, it may seem easier to follow the lead of peers and become downbeat in a bear market.
However, going against the consensus view can be profitable in the long run. The market cycle shows that bull markets and bear markets never last in perpetuity. Investors who take a long-term view and use market fluctuations to their advantage may unearth better risk/reward opportunities than their sentiment-driven peers.
Following the stock market cycle
The market cycle provides opportunities for investors to buy high-quality stocks at low prices. It also offers the chance to sell them at higher prices further down the line, should an investor wish. Indeed, there have been 27 bull markets since 1928. In that time, there have also been 26 bear markets.
Logic dictates that an investor must adopt a contrarian stance to fully take advantage of market fluctuations. Otherwise, they would end up buying stocks after they had risen in price because investor sentiment is generally more upbeat at such times. Similarly, they would be more likely to sell stocks after they had fallen and when many investors are generally downbeat about their prospects.
Therefore, a simple strategy that seeks to contrast with sentiment among other investors could be a sound approach. It may provide greater opportunities to apportion capital efficiently.
The difficulties of being a contrarian investor
Oaktree Capital cofounder Howard Marks (Trades, Portfolio) is a well-known contrarian investor. As he previously stated:
"Certain common threads run through the best investments I've witnessed. They're usually contrarian, challenging and uncomfortable – although the experienced contrarian takes comfort from his or her position outside the herd."
Marks' comments highlight not only the success that a contrarian investment strategy can provide, but also the challenges it poses on a practical level. It is difficult to ignore the views of other investors and instead rely on your own judgements when they are very different to the consensus. For example, seeing other investors generate high profits in the current bull market may tempt an individual to buy stocks – even if they are overvalued.
Indeed, it takes a large amount of discipline to hold cash while the stock market is rising. Low interest rates mean there is currently a significant opportunity cost of holding cash that can be an uncomfortable experience for even the most devout contrarian investor.
A practical perspective
In my opinion, a possible solution to the challenge of being a contrarian investor is to take a long-term view. This could allow an investor to overcome the mental anguish of missing out on gains in a bull market. Similarly, it may help them to cope with the disappointment of experiencing paper losses in a bear market.
In addition, focusing on the opportunities provided by a contrarian approach may be helpful in implementing it. The average decline during a bear market has historically been around 36%. This could mean future buying opportunities are significantly more attractive than they are today. Likewise, the average return in a bull market of approximately 112% means that waiting for wider margins of safety could be a far more profitable move than buying today's richly-valued stocks.
Ultimately, bull markets and bear markets are likely to be temporary in nature. Since buying low and selling high is likely to be the central aim of most, if not all, value investors, a contrarian strategy seems to be the obvious approach to take in a variety of market conditions.
Disclosure: The author has no position in any stocks mentioned.
Read more here:
- Li Lu: Honesty Is the Best Investing Policy
- Why Warren Buffett's Views From the Tech Bubble Are Useful Today
- Seth Klarman: Industry Knowledge Can Provide an Investing Edge
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