Playing Armchair Contrarian are about to embark on a long-term bull market as we did
in 1982, when buying shares of the Dow Jones was truly a A
Now let’s examine a few current themes for contrarian investing contrarian move. Moreover, according to an April 26 Barron’s C
in today’s turbulent market. I would like to preface this section by survey of Institutional Investors (the so-called smart money), a T
providing you with the classic cover-your-butt clause and say that I whopping 81% of respondents are either bullish or neutral on I
the prospects of the stock market over the next year. This type
do not recommend you pursue any of these strategies as you will likely C
of sentiment is a contrarian’s worst nightmare.
lose money on them. These are simply examples and are meant to S
supplement this discussion on contrarian views. Foreign Markets
Edition 5 . Volume 8
On the Contrary
How about Japan? In 1990, the Japanese stock market began
With house prices in certain parts of the U.S. falling off the edge to collapse. The index hit an index price peak of 39,000 and
of a cliff over the last year or so, one would automatically assume then starting dropping like a stone. At 25,000, analysts viewed
that prices somewhere in the U.S. would appeal to contrarians. the crisis as being over; every time the Nikkei fell, it was
A Brief Look at Contrarian Investing
Maybe so, but measuring how much house prices have dropped is viewed as another buying opportunity. But it just kept getting
not enough; one must also look at where they came from. In this worse and worse. Today (May 2008), you can buy the Nikkei
regard, most contrarians would shy away from an asset unless it is for 13,655 – a 65% discount from its peak.
hitting decade (or sometimes multi-decade) low prices. Houses While Japan is full of problems with its aging demographics,
in the U.S. do not qualify. There are probably some areas in the closed border policies, high levels of debt, and relatively low
U.S. (e.g., Detroit) where home prices are at multi-decade lows and domestic consumption to name just a few, all of this glum news
would appeal to a contrarian, but on average they are not. is exactly what makes for a perfect contrarian bet. That being
Oil said, there is at least some hope for this battered economy,
including the fact that Japan is one of the few countries in the
Buying into oil or oil stocks at this point is most assuredly not a world that pretty much avoided the hodge podge of sub-prime
contrarian investment. Prices have been rising consistently and investment vehicles.
above most people’s expectations for the past eight years. Oil was a
contrarian investment at the beginning of the decade, when many
analysts were debating whether US$10 or US$20 per barrel was
the long-term price. In fact, a case could be made that oil is at The purpose of this newsletter is not to make general or specific
multi-decade highs, so if there is going to be a contrarian view, investment recommendations, but to make observations about
it should be bearish - that oil prices are in a bubble and poised to how contrarian investors tend to think and to provide examples
fall. Interestingly enough, general Wall Street sentiment actually of the types of scenarios that appeal to them. I do not pretend
expects a fairly sharp correction in the price of oil. In order to to be a contrarian investor, although I am sure I have, in the
consider this a contrarian prospect, there must be consensus past, unknowingly made some investments that would be
considered contrarian. I also don’t think of this investment By Kash Hashemi, CFA, MBA
agreement in the market and stocks must be priced accordingly.
style as a good way to accumulate wealth for retirement.
Gold any years ago, as a recent know-it-all University at low price-to-book ratios or offering a high dividend yield
The main point is that contrarians tend to think outside the graduate, I optimistically embarked on a is a contrarian investment, which was surely not true. To no
Similar to oil (although not to the same extent) gold prices have box. In looking for themes, contrarians prefer small probability career search with high hopes of landing a one’s surprise, I didn’t get the job. The good news is that life
been rising consistently since the start of the decade. Gold was events with big payoffs and, consequently, tend to lose money well-paying job that would make any mother proud. After tends to give you second chances. This time, I will attempt
a contrarian investment in the early part of the decade when it on their trades more often than they make. But unlike
was fetching less than US$300/oz. Contrarian thinker and author more than a few interviews, it became dishearteningly to define what it means to be a contrarian by:
professional sports, investment success is not measured by the apparent that it would actually require years of hard work.
of “Financial Reckoning Day”, Bill Bonner has made a name for number of wins vs. the number of losses. Contrarian investors
himself by calling his trade of the decade in 2000, where he sold care about the cumulative ‘score’ in each of the ‘games’ they
the Dow Jones and bought gold. It is not the end of the decade yet, I recall one particular interview where I was asked to define what
play, win or lose. If you can win big and lose small, then it
but it is far from the beginning. it means to be a contrarian. After an uncomfortably long pause,
makes frequent losing a tolerable price to pay.
I remembered a small blurb from one of my many overpriced in this issue: SUMMARY
With logic like that, it’s probably a good thing I wasn’t Finance textbooks that described contrarian investing as
As for North American stock markets, the Dow Jones or S&P 500 interviewing for a position with a professional sports franchise. “a sub-set of the value investing discipline.” I proceeded to In the world of Finance, going against the grain
could hardly be called contrarian investments today. With trailing Or maybe I should have become a comedian after all. provide the interviewer with a standard textbook answer: a is sometimes bold, sometimes ill-advised, but
price-earnings ratios around long-term averages and the prospects contrarian is an investor who buys securities that are out of usually both. So when looking at an investment
for earnings looking weaker by the month, it is unlikely that we
favour according to some well-defined, fundamental measures, that’s fallen out of favour or ignored by the
such as low price-to-book ratios or high dividend yields. market, how does one know when it’s right to
buy, or even if it’s a good idea? In this edition
A Before I realized I had placed my foot directly in my mouth, the
of Tactics, Portfolio Management team member,
C Vancouver: interviewer dismissed my shallow response by pointing out that
Head Office: 5th Floor - 1508 West Broadway, Vancouver, BC V6J 1W8 Tel: 604-739-6450 Kash Hashemi, guides us through the discipline
T he asked me what it meant to be a contrarian, not what it meant
Kelowna: of Contrarian Investing.
I Landmark III Suite 520 - 1632 Dickson Avenue, Kelowna, BC V1Y 7T2 Tel: 250-763-9757
to be a contrarian investor. He also pointed out that my defi-
C nition for contrarian investing suggests that any stock trading
• Exploring the contrarian thinker and offering a non- What does this have to do with contrarian thinking or taught that the majority rules, so having a minority opinion causes A simple example (though admittedly extreme)
financial example of contrarian behaviour; investing? Solon displayed a contrarian thought process them to examine why they are wrong as opposed to why the helps illustrate this point:
• Defining contrarian investing; because he understood skewness: that frequent success is majority might be wrong.
meaningless if failure is too costly to bear. Contrarians apply Let’s consider the $10,000 purchase of a security and
• Providing a simple example of a contrarian investment; and This reminds me of times when, after writing an exam, I would ask assume that 10% of the time it will be profitable. Half the
this concept by considering both the probability of an event
• Examining current contrarian signs. two or three of the “smart” students in the class how they answered time it will generate a total profit of $150,000 and during
occurring and its outcome. This is in contrast to normal
certain questions. If their responses were similar to mine, I would the other half, it will generate a total profit of $300,000.
human behaviour, which tends to ignore the very low
get a sense of comfort. It never really occurred to me that our Let’s also assume that 90% of the time, this security will
probability event (being captured by King Cyrus) regardless
The Contrarian Thinker of the severity of the outcome (being robbed of your wealth).
responses could be the same and incorrect all at the same time. eventually be worth zero, thereby creating a loss of $10,000.
In some ways, contrarians are a little like comedians in that From here, we can create the potential outcomes as shown
they test the boundaries and challenge the status quo.
The Contrarian Investor The Math
Comedians often go out of their way to present ideas that 100%
In the world of Finance, we are constantly reminded about a study
sound absurd. Sometimes the audience laughs. Other Very generally, the contrarian investor displays intellectual
done for the SEC (Securities & Exchange Commission) which Security Loss
times the level of absurdity exceeds the audience’s ability independence with a large dose of skepticism about consensus Becomes
came to the conclusion that 90% of all options* expire worthless. -$10,000
to comprehend what is being said, resulting in awkward views. It is an attempt to profit by betting against the consensus. 90% Worthless
This means that 90% of the time, the buyer of an option will lose
silence. A contrarian thinker offers opinions that are Essentially, the contrarian does three things:
amusing at times and incomprehensible at others, also often 1. Watches for popular and neglected areas of the market
resulting in awkward silence. Because of this piece of data, some very well-respected minds in Invest in Big Win
2. Comments on the crowd behaviour in markets Security +$300,000
the financial industry make the claim that buying options is a
However, unlike a comedian, a contrarian doesn’t just conjure 3. Uses a very small portion of total investable $10,000
losing proposition. They therefore conclude that selling options
up absurd ideas. Normally, the contrarian’s thought process funds to act on a contrarian investment idea is a winning proposition since option trading is, by definition,
involves the direct or indirect calculation of probabilities 50%
Contrarian investors know that they’ll be wrong more often a zero-sum game (i.e., your gain is someone else’s loss and your loss Security
and outcomes in an attempt to prove that what he or she Sold for Small Win
than right. They also understand that they don’t need to be is someone else’s gain). Sounds pretty logical, right? Actually, if 10% +$150,000
is saying is not as far-fetched as it appears. Contrarians are a Profit
right most of the time, because when they are right, they you do the math, it is not that logical at all.
generally well aware that their ideas sound crazy, but they’re 50%
expect the payoff will be large enough to make up for all the Assuming we can take the study results as fact, the idea that 90%
also confident that their ideas aren’t as crazy as they sound.
times they were wrong. of all options will eventually be worth zero should be meaningless.
One of my favourite non-financial examples This is because it only takes into account the probability of an In this greatly simplified example, we can calculate the
The point here is that a contrarian utilizes the
of contrarian thinking comes from the book event occurring while completely ignoring the potential outcome. expected dollar profit, since we know the probabilities and
state of investor psychology as a form of idea
‘Fooled by Randomness’ by Nassim Nicholas Contrarians test In other words, what matters is the amount outcomes for each of the three possible scenarios:
generation. And here is where the contrarian
Taleb, a brilliant book that forces you to think the boundaries of money that was lost
may have a leg up, because if there’s one thing (0.10)(0.50)(300,000) + (0.10)(0.50)(150,000) + (0.90)
outside the box. The book begins with the 90% of the time vs.
and challenge that’s fairly predictable about markets, it’s (1.00)(-10,000) = $13,500
story of Solon’s warning to Croesus, King of the amount of money
the status quo. investor psychology. At market tops, jubilation
Lydia. Croesus, one of the richest men of his that was made 10% Here is a situation where the probability of loss was 90%,
turns into denial, which eventually turns into
time, was visited by the Greek legislator, Solon. of the time. but the expected outcome was a 135% gain (or $13,500
reality, which turns into fear, which results in
Solon was indifferent to Croesus’ wealth and profit on a $10,000 investment). This is what skewness
capitulation at market bottoms. At market *An option is a derivative
told him: “The observation of the numerous misfortunes that (or asymmetry of returns) is all about, and this is what
bottoms, investor psychology works all the way back up to security, a financial security
attend all conditions forbids us to grow insolent upon our whose characteristics contrarian investors pay attention to.
present enjoyments, or to admire a man’s wealth that may yet, and value depend on (or
in course of time, suffer change. For the uncertain future has The challenge, of course, is that nobody knows how long this are derived from) the To the contrarian investor, the $10,000 investment has
process is going to take and how high or low the crowd’s characteristics and value an expected profit of $13,500. Sounds good, doesn’t it?
yet to come.” of an underlying security.
psychology will reach. In this regard, the contrarian knows For the purpose of this Well, yes and no. It is a good expected outcome, but if
In other words, “it ain’t over ‘til it’s over.”
full well they cannot predict with certainty the exact time to discussion, I will greatly you back the truck up on this trade, you will be penniless
Years later, Croesus would lose in battle to the Persian King, get in or get out. simplify the example such 90% of the time. However, if you put a very small portion
that it is not necessary to
Cyrus, be stripped of his riches, and concede to Solon’s of investable funds to this strategy, over the long term (at
On paper, the strategy sounds very simple. In practice, it understand how options
wisdom. He realized that it was impossible to be called work. least statistically) you should do very well on the trade.
requires a different mentality, one which most humans are
the wealthiest man who has ever lived, because there was a As mentioned before, in theory this is how a contrarian
just not wired for. For one, it can be extremely uncomfortable
possibility, albeit a miniscule one, that the wealth could be looks to make money. In practice, however, it’s quite
to be wrong and contrarian at the same time, especially when
taken away. difficult.
money is on the line. Secondly, most people grow up being
J une 200 8 w w w. n i c o l a w e a l t h . c o m A Newsletter to aid business owners and professionals in obtaining their financial goals. June 2008