Sunday Edition: The Art Of Contrary Thinking

November 13, 2016

Sunday Edition: The Art Of Contrary Thinking

I bought my first shares in a publicly traded company in ‘95, as a 22 year old college dropout. I can’t remember the name of the company or the ticker.

What I can remember is that it was a hot tip from a friend and a pink sheet stock, although at the time I didn’t know what that meant. Yes, the company went out of business and I lost $2,000 bucks.

Back then I was eager to learn and devoured every book I could get my hands on, that I believed held the key to getting rich in the stock market.

I gravitated toward books focused primarily on technical trading, which I believe happened for two reasons:

  1. They fascinated me. Trends, oscillators, patterns, overbought, oversold, the possibility of pulling profits out of the market quicker than buy and hold. It kept me intrigued.
  2. What’s a kid from the poor side of the tracks uneducated in Academia going to do?  Read books on balance sheets, income statements, cash flow statements (Yawn)?

I have since taught myself to dig deep into 10-Qs and 10-Ks and appreciate the financial statements of a publicly traded company and realize how valuable they are to your success as an investor and even a trader.

But I haven’t forgotten my roots (technicals). I even take a bit of pride in the fact that, as they say, I’m a “tape reader,” something that seems to have fallen out of favor for the time being (don’t worry it will stage a comeback).

When you buy shares in a public company I believe you must have a firm understanding of exactly what the company does, and how they generate profits. You are buying a business and becoming an owner in that business. Therefore, the day-to-day fluctuations (things technical traders fret over) matter less and less.

In my current privately held financial research and publishing firm, I can’t gaze at the ticker tape watching the day-to-day volatility in the share price. That’s probably a good thing, or I may have “panic sold” at various times over the last 16 years.

When you have a correct understanding of a business, it’s fundamentals, and therefore its true underlying value, it gives you the necessary conviction to hold even when Mr. Market temporarily puts the business on sale for way less than it’s worth.

However, I still believe technicals can and should play a role in helping you better time your entry into what otherwise appears to be a deeply undervalued investment opportunity – with a high margin of safety, of course.

When it comes to trading something like coffee futures, technicals become even more important as do other things such as macroeconomic trends and global supply/demand pressures and even weather patterns. Good luck trying to predict the weather, although it does seem to move in cycles of being more mild at times and more erratic at others. My colleague Sven wrote about that here.

I believe both technicals and fundamentals play a significant role in your long term success as an investor. However, and to the point I’m really driving at, there is one area, in my opinion, that stands heads and tails above both technicals and fundamentals when it comes to being successful and earning market beating returns, and that is the way you think.

Yes I’m talking about managing your own emotions—that’s critical—but even more important is recognizing when others are not properly managing their emotions, for therein lies the opportunity to make outsized returns as a contrarian investor.

In my opinion The Most Important Thing, a book by Howard Marks, is just that, a book on the most important thing – how to think like a contrarian. I believe every serious investor should own a copy and read it at least once a year.

In rereading the book this year, I decided to pull some of the things I had underlined the first time I read the book several years ago, and share them with you. They are true gems.

Many of the best bargains at any point in time are found among the things other investors can’t or won’t do.

In the world of investing, being correct about something isn’t at all synonymous with being proved correct right away.

The safest and most potentially profitable thing is to buy something when no one likes it.  Given time, its popularity, and thus its price, can only go one way: up.

It’s essential to understand that fundamental value will be only one of the factors determining a security’s price on the day you buy it. Try to have psychology and technicals on your side as well.

“I wouldn’t buy that at any price – everyone knows it’s too risky.” That’s something I’ve heard a lot in my life, and it has given rise to the best investment opportunities I’ve participated in…

When everyone believes something is risky, their unwillingness to buy usually reduces its price to the point where it’s not risky at all.

There is a right time to argue that things will be better, and that’s when the market is on its backside and everyone else is selling things at giveaway prices.

The pendulum cannot continue to swing toward an extreme, or reside at an extreme, forever, although when it’s positioned at its greatest extreme, people describe that as having become a permanent condition.

There are few things of which we can be sure, and this is one: Extreme market behavior will reverse. Those who understand the pendulum’s behavior can benefit enormously.

Many people possess the intellect needed to analyze data, but far fewer are able to look more deeply into things and withstand the powerful influence of psychology.

Recognition of divergences from consensus thinking must be based on reason and analysis.  You must do things not just because they’re the opposite of what the crowd is doing, but because you know why the crowd is wrong.  

Most people say, “We’re not going to try to catch a falling knife; it’s too dangerous.” They usually add, “We’re going to wait until the dust settles and the uncertainty is resolved.” What they mean, of course, is that they’re frightened and unsure of what to do. 

To improve our chance of success, we have to emphasize acting contrary to the herd when it’s at extremes, being aggressive when the market is low and cautious when it’s high.

Low price is the ultimate source of margin for error.

I think every investor and trader would do well to adopt these Marks-isms in their pursuit to create wealth in the financial markets.

The other day while sifting through Bloomberg, looking for something interesting to read, I came across an article Why Investors Must Be Contrarians To Outperform The Market. It is hands down one of the best pieces I’ve seen written on the subject.

Something the author said, that I really appreciate (and I’m paraphrasing) is, you don’t want to be a contrarian just to be a contrarian. If a building is on fire you join the crowd who is right in running for the exits and you get out of dodge. You don’t do the opposite and be a contrarian by running into the burning building.

So being a contrarian isn’t about doing the opposite of the crowd just to spite the crowd. The key is knowing when a true contrarian opportunity exits and then having the courage to take advantage of it.

Next week I will share with you what I believe is one of the best contrarian ideas that you can take advantage of in today’s market. I believe it is sure to produce outsized returns. No, it has nothing to do with gold, oil, or grains. This is a company specific opportunity.

And don’t forget to pick up a copy of Howard Marks’ book.


Shane Rawlings
Founder, Investiv