When the crowd zigs, you should probably zag. At least that’s the theory advocated by contrarian investing. Over the course of time, investing in out of favor sectors has been an approach that would beat the market. This is the approach advocated by David Dreman, a famous contrarian investor, in several books. But it’s only one approach that beats the market.
Why would this work? Because when the market spits something out that tastes bad, it spits too much out. I have an uncle that won’t eat pepperoni pizza because it made him sick once. He won’t eat it again. The market has a shorter memory than my uncle, but it’s a memory that’s just long enough to sometimes create inefficient pricing. If a sector like financials is out of favor today, the market may over depress prices, only to see them bounce back over time. Many financials are down over 50%. Bank of America (BAC), for example, is down 64.96% over the last 52 weeks. Maybe those stocks should only be down 45%, a 20% difference in the case of BAC.
I’m not saying that’s necessarily the case. The truth is, I don’t know. What I do know is that bargains form the same (or opposite, depending on perspective) way that bubbles do. Bubbles form when people are overly optimistic, and bargains form when people are overly pessimistic. A contrarian looks to profit from this pessimism. When people are zigging, the contrarian zags, and often it makes him or her money. Thanks for reading.
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I really liked this topic! Well said!
Thanks Rachel! Disclaimer – Rachel is my wife. Obviously she’s a big fan of the blog. She was my first RSS subscriber.
I wish I could recall the name of the radio talk show host who focused on investing so I could give credit where credit is due. Unfortunately, I’ll have to take credit just for remembering the one phrase that made so much sense to me; “Lions buy when sheep sell; Sheep buy when lions sell.” Whenever you’re trying to decide whether or not to get into or out of a market, ask yourself what the lions are doing.
I have run an RIA firm in OP for the past 12 years, and we have seen all types of market fluctuations during that time. The greatest single indicator of predicting the markets next move, is what we call the “house wife” phone call sorry to any that might be offended. With 100 % accuracy, that phone call to sell, or buy for that matter, is the most accurate indication of the markets next move….but it will, of course go the other direction….