Quite Contrary
How Do Contrarian Investors Survive When There's No Consensus to Fight?July 21, 2006
Being a contrarian investor is rarely an easy life. It's lonely business buying stuff everybody else is dumping or selling stuff everybody else is buying. Only rarely are there moments when the contrarian play is as easy as falling out of bed -- at the height of the tech bubble, say. But it is especially hard now, with asset classes moving up and down in tandem and contradictory emotions battling for supremacy on Wall Street. At the risk of oversimplifying it, a contrarian keeps a close eye on broad sentiment for a market, stock or other investment, always looking for emotional extremes that knock prices out of whack with reality and present a buying (or short-selling) opportunity. It is tough to find any such extreme at the moment, at least not in relation to the broad U.S. stock indexes. Last week's panic-inducing selloff has been partly erased by this week's exuberant rally, continuing an up-and-down pattern of recent months that has left the Dow and the S&P 500 nearly unchanged for the year and the Nasdaq down about 6%. Jason Goepfert, chief executive of Sundial Capital Research, keeps track of a long list of sentiment indicators at his site, Sentimentrader.com. Of the dozen short-term indicators he follows, three are flashing bullish signs, but the other nine are stuck in neutral. Meanwhile, 15 of 20 longer-term measures are neither bullish nor bearish.Bonds, too, are loved and unloved in seemingly equal measure. In a recent ABC Radio interview, famed contrarian Marc Faber recommended people buy just one Treasury bond, to "frame it -- put it on the wall so they can show their grandchildren how the U.S. dollar and how U.S. dollar bonds became worthless as a result of monetary inflation." But Treasury notes are popular lately as more than just museum pieces, as rising geopolitical tensions and expectations of an economic slowdown have inspired a flight to safety.In this environment, we talked to three contrarians about how they're coping.
James Bianco:Q: Do you consider yourself a contrarian?
A: Yes. But there are times when the conventional wisdom appears to be working, and there are times when the measurement of what you think is contrarian will fail you.James Bianco is president of Bianco Research1, L.L.C., in Chicago, an affiliate of Arbor Research & Trading, Inc., specializing in macro investment analysis of the equity and fixed-income markets. A great example of this was in 2003. The stock market in March 2003 was slumping, and everybody said, wait until the Iraq war is over -- when they blow the all-clear, it will be time to buy stocks. If you believe in contrarian opinion, you discounted that talk. But it did work exactly that way. The dumbest trade of decade was being a contrarian on May 1, when Bush landed on the aircraft carrier and said "Mission accomplished." If you had bought stocks on May 2, you'd have been up more than 40% three years later.
Q: So there are not always contrarian plays available?
A: Contrarian plays are situational. I would say I'm a contrarian, but 90% of the time in a given market, there's no contrarian play to play. You have to wait until some kind of extreme develops and lean into it. I don't look at some measure and say, "Sentiment is 51% bearish, so I'm going to buy." It's got to get to 80% or 90%.
Q: Where do you see sentiment for bonds right now?
A: We're in a period of transition. From 2002 to about six months ago, bonds were wildly hated by the crowd. Now, while there are still probably more bears than bulls out there, it's starting to [get closer to] a 50/50 split. Sentiment is not as extreme as it was this time last year, when it was very difficult to find any bond bulls at all. But the majority is still bearish right now.Q: What is your outlook for bonds?A: We do think the biggest fear bonds have now is the inflation fear. Inflation numbers have not been looking too good, and that's going to continue to put upward pressure on long-term interest rates. I'm not that bearish on the economy, either. I think it's going to surprise to the upside.
Q: Sounds like you disagree with Ben Bernanke, who just told Congress the economy was going to slow down and take inflation down with it.TELL US WHAT YOU THINK Send comments to tradingshots@wsj.com2. If you want to share your thoughts but don't want your letter published, please make that clear.
A: He was talking about the Fed's official forecast. Every time Alan Greenspan used to go up to the Hill, Sen. Paul Sarbanes (D., Md.) would go though chapter and verse of the Fed forecast of years past and conclude the thing is never right. Mr. Greenspan would always agree. Everybody should view the Fed forecast as just another opinion. It's no better or worse than Merrill Lynch's opinion, for example.I still think I'll take the over on the economy. I still bet it will be better than expectations. And I'm not concerned the Fed thinks the opposite, given their track record.
Q: What do you make of the fact that nearly the entire yield curve is trading below the fed funds rate?
A: In the past, the curve inverted when interest rates were at a punishingly high level. The inverted curve was another way of saying, here's a period of punishingly high long-term rates, where most financing takes place. I'm of the opinion that, since long-term rates are not at punishingly high levels, I don't think this inversion is worrisome.But now that I've said that, I'll give you a great contrarian call: I also see that Mr. Bernanke is saying the same thing. So now I'm more worried about that.* * *
David Dreman:
Q: How do you see market sentiment right now?
David Dreman is chairman and chief investment officer of Dreman Value Management3 in Jersey City, N.J., and the author of "Contrarian Investing" and several other books about contrarian strategy.
A: If you look at the market indexes, sentiment is still towards "value" stocks [or stocks seen as underpriced, as opposed to "growth" stocks, which may be expensive, but have consistently strong earnings growth], as it has been since the tech crash. Take something like the Russell 1000 Value index or the small-cap Russell 2000 Value index. Both are way ahead of growth [stock] benchmarks.
Q: So sentiment seems to be in your favor right now, as a value investor. How does that fit in with being a contrarian?
A: We use the term "contrarian" in a stricter sense than a lot of people do. We use it to mean we're looking for stocks with a lower price-to-earnings ratio than the market, low price to cash flow, and low price to book value and also a high yield relative to the market. There are many studies that show that stocks, if judged by these metrics, have done significantly better than the market.
Q: That sounds like a different animal than what some people consider "contrarian," which is simply moving in the opposite direction of sentiment.
A: That's a very short-term approach. That's almost market timing in a sense. What we try to do is find stocks that are pretty cheap. Sentiment is usually running against them, and that's when we buy them. The term "contrarian" was coined from one of my books. My editor coined it, actually. I didn't like the term, but he turned out to be right. Anyway, ours is a much more strict application of the term.
Q: Do you see opportunities out there now?
A: There was a pretty dry period when there wasn't much out there. There do seem to be more opportunities now, especially since the market has come down. There's not as much as I'd like to see, and the values are not as deep as I'd like to see them. We're not seeing stocks we think are even doubles or triples, never mind four-baggers. But there are some opportunities.
Q: What are some of those?
A: Some of the stocks we've owned are tobaccos. They've done extremely well. Some health-care stocks have worked well. Oil got beaten up badly in May; we took advantage of some of that.
Q: Are there always contrarian opportunities?
A: I think there are. Sometimes there are enormous opportunities, other times so-so. We are coming out of a so-so period and getting a little better. But there's nothing out there like there was in 2002 when the markets collapsed. We're in-between.
Q: Lots of people are talking about playing defense. Is going on offense right now a good idea or a recipe for disaster?
A: One of the things we've learned is you want to be patient. If you have some powder and there's nothing much out there, keep it dry. Very often when there are not lot of opportunities, you'll have better chances ahead.
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Bill Fleckenstein:
Q: Is this a hard time to be a contrarian, when there is no glaring herd pattern out there?
Bill Fleckenstein is president of Fleckenstein Capital4 in Seattle, which runs a short-selling hedge fund.
A: Let's start with the concept of being a contrarian. I think some people think it's a lifestyle or something like that. It's true that, if most people are skewed to the same idea, then the other side is probably priced too cheaply. If it gets out of whack enough and a constructive case can be made for the other side, then maybe there's an opportunity there. But that doesn't mean things can't be priced too cheaply for an extended period of time. And it doesn't mean that every thing or every asset class at every moment has a contrarian investment case to be built.
Q: So do you see any tradeable sentiment on Wall Street?
A: There is a modest amount of angst, but I really don't see very many people who are all that nervous. They're thinking, maybe the market will go down a bit, maybe until we have a 10% correction, or until the Fed stops. Almost none are saying what I think the real case is: We had the biggest market mania in the history of world, and then that was bailed out by the housing mania. As that comes unstuck, you could make a solid case for a very nasty recession that is not priced in a lot of stocks -- which is why I want to short stocks or the dollar. If people understood how tenuous the U.S. economy is, I don't think the Dow would be close to 11000. It would be a lot lower.
Q: Still, there seems to be a lot of talk about people becoming defensive. Does that mean the pure contrarian trade would be to go on the offensive?
A: Being contrarian for contrarianism's sake is a waste of time and a recipe for a lot of grief. If you're always willing to examine the other side of what seem to be lopsided viewpoints or unexamined viewpoints, you often find that the other side appears to be dramatically mispriced. You're really trying to exploit mispricings, not holding a mindset of, "Whatever that guy thinks, I'm thinking the opposite."
Q: What are some of the investments you see as unloved?
A: One of the things that strikes me as quite unloved and discredited is short-selling. I'm not talking about the whole naked-shorting, black-hat stuff. But I think we're going into a dicey period, and I don't see an attempt on the part of pros to increase their short exposure. I think that's an idea with a real interesting future, and nobody's really doing it. The trouble is, it's not a suitable thing for most people to do. It's kind of a professional discipline. It's not something you can do part-time at home.
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