Contrarian Investing: Easy to Say, Hard to Do

One year ago, traders should have been buying with both hands. What should they be doing today?

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Feb 13, 2017
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It’s now almost exactly one year since stocks hit a very scary bottom. You can excuse yourself from this article’s criticsm if you were a big buyer of stocks during January and February 2016.

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The majority of traders, though, reacted to headlines like the one below by panic selling. They were scrambling to avoid even larger losses if 2016’s early-year sell-off morphed into “the next 2008.”

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Going into Jan. 9, 2016, the DJIA was off by 6.2% and showed no signs of leveling out. The old adage that “As goes the first five trading days… so goes the full year,” could be heard everywhere.

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Math geeks would have noted that the broad-based S&P 500’s 50-day moving average was already greater than 3.5 standard deviations below normal. That was scary to those glancing backwards, but should have been mouth-watering for visionary inverstors.

Outlying results almost always revert back towards the mean. Extreme outliers tend to regress quickly, often violently, back towards normal.

Investors who sold into 2016’s early-year carnage seemed to have learned nothing from their August to September 2015 experiences.

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Following Jan. 9, 2016, worldwide markets ebbed and flowed for another month or so before carving out their final bottoms.

All three major U.S. indices took off from there and never looked back.

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Mid-February 2016 declines of around 10% for large-caps, and 20% for small-caps, turned into nice total returns by Dec. 31. Now, on the one-year anniversary date of the true nadir, trailing 12-month returns run from nearly 28% to north of 33% for the ETFs (SPY, DIA, QQQ) representing the S&P 500, Dow Jones Industrials and the Nasdaq 100.

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Brave souls who ventured into small-cap mutual funds last winter appear brilliant today. I used the closed-end Royce Micro-Cap Trust (RMT, Financial) and the Royce Value Trust (RVT, Financial) for that purpose last February.

As of one year ago, those funds’ trailing 52-week returns were putrid (at negative 25.4% and negative 23.8%, respectively). The market prices’ discounts to net asset value were both running way above normal at close to 18%.

Buyers were getting already beaten up shares for well under face value. The larger than typical discounts to NAV suggested a regression to the mean on that score would serve to boost dividends and future capital gains as well.

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Negative thinkers, at major low points, love to point out that after a 25% decline you’ll need a 33% increase just to break even. They neglect to mention that new money committed to shares after large sell-offs will benefit from that math.

Fast forward 12 months. The predictable exaggerated rebound is exactly what those two Royce closed-end funds achieved. NAVS have surged, discounts have narrowed and reinvested quarterly dividends compounded.

As of Feb. 10, total return on the Royce Micro-Cap fund was 50.4%. The Royce Value Trust did even better at 54.7%. Both handily exceeded the fine numbers previously noted on the SPY, DIA and QQQ ETFs.

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A year ago, sentiment was wildly bearish. Now, it’s greed which appears to be the dominant market force.

The easy money has been made. Most stocks are now far from cheap. If you’re already long-term on shares that have run up dramatically, it might be time to take some money off the table.

Stop being a dumb ass.

Disclosure: I have sold my RVT and RMT shares. No positions in them at this time. I own no ETFs or index funds.

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