Thursday, December 18, 2008 0 comments ++[ CLICK TO COMMENT ]++

Good note on contrarian investing

Financial Post--WSJ of Canada--has a good note on contrarian investing. The content mostly seems to come from a Citigroup analyst note but it's interesting to me. I think relying on some wild guesses at a party to form theses can result in incorrect results. But nevertheless, the analyst seeems to capture some insight. I think some of what is described describes some of my investing, thinking, and behaviour this year. Let me highlight some interesting things and throw in my opinion as well:

Before I say anything, it should be noted that the verdict is still out on many of the investments. Some people have posted large share price losses but they may be irrational "quotational" losses. In contrast, others have posted real losses. We probably won't know what the final outcome is for several years.

Contrarian investors may have done really well when the tech bubble burst, but similar strategies haven’t fared very well since 1997 and 2008 was another poor year for their track records.

They likely called the top in global trade growth but probably gave back the gains attempting to predict the bottom in financials. Meanwhile, contrarian asset allocators should have done far better, since they would have been bearish on risk assets a year ago.

I have only been investing (seriously) for a short period of time but, from my historical knowledge, I agree with that point made above. A lot of so-called contrarians making specific calls have done poorly whereas they did well back in 2000. A good example is someone like David Dreman who got clobbered in the current meltdown. Dreman posting huge losses is kind of shocking because he is a diversified investor and was holding stocks in many different sectors.

The contrarian asset allocators have definitely done really well. A good example is Jeremy Grantham who not only called the housing bust and the stock market bubble--he called the rally from 2003 the biggest sucker's rally in history--but seem to have side-stepped major losses (do note that he is a strategist and he doesn't really run a particular fund so it's a bit unfair to compare against others.)

I think the problem for many contrarians this time around was the fact that there were misleading signals all around. In the late 90's, the tech bubble was obvious and you just had to avoid it (along with growth stocks of any sort.) In the current meltdown I think almost all contrarians, including a dumb guy like me ;), knew housing was a bubble and bursting. Contrary to what many think, housing actually peaked in 2005 (not 2007!) so a contrarian call on that wasn't hard. Housing stocks also peaked somewhere around that time (this is why Bill Miller was buying housing stocks in 2006.)

I think many contrarians, especially the top down ones, also were aware of the low risk premium investors were willing to accept. I think where we went wrong was with the magnitude of the impact. Even Jeremy Grantham, who called it correctly, was surprised at how bad the situation was. I suspect others like Marc Faber, who had the general picture right, likely suffered sizeable losses (I have no idea what Marc Faber invested in but he was bullish on emerging markets, particularly Vietnam and the like, and wouldn't have made it out alive from EM).

Contrarians appear to be better at macro calls such as sector, regional and asset allocation moves, Mr. Buckland said.

I think this is true but it is also false in some sense. Of the contrarian-type investors I follow, they tend to have an easier time making a macro contrarian call but very few can get the timing close enough to be low risk. Macro contrarian calls are easy because, at times, valuations make no sense and you can go against the crowd. For instance, the long US bonds are in a bubble and it's easy to say that they will decline because bond yields are near(?) all-time lows, but timing is really tough.

Right now, contrarian asset allocators are likely buying equities and selling government bonds. Meanwhile, contrarian stock pickers should be buying financials and selling pharmaceuticals and biotechnology.

As a result of low equity valuations, Citigroup is more willing to back the contrarian asset call than the contrarian stock call right now. “Contrarian stock pickers probably need a turn in the global profits cycle, which we do not expect until 2010,” Mr. Buckland said.

This makes no sense to me. If you are a contrarian, you are supposed to be ahead of the consensus. Waiting for the profit cycle to turn seems to defeat the whole point of going contrarian. I completely disagree with the strategy here. I actually think stockpickers are better off right now than macro investors. Macro is a minefield right now because there are no obvious under or over-valuations (other than some limited ones such as the US bonds.) In contrast, stock valuations are getting attractive by the day and, if you go with some of the works of David Dreman, contrarian stocks should perform well in bear markets even if news is bad. As examples, Pulte Homes (PHM) and Toll Brothers (TOL), two of the leading homebuilders in the US, are actually up around 15% for the year while the S&P 500 is down 40%. Who would have thought that two of the leading homebuilders would be doing so well in the middle of a housing bust, not to mention a credit bust? Anyway, stockpicking is the way to go right now.

His market-neutral contrarian buys the worst and sells the best ten performers from the previous year, with a universe of the 250 largest global stocks. This approach has produced a positive return in only four of 11 years, while the return was only meaningful in 2000. In fact, if $100 was invested in this strategy in 1997, an investor would have just $33 remaining.

For example, a contrarian bull would have bought Royal Bank of Scotland this year as it lost more than a third of its value in 2007. However, it has fallen more than 85% in 2008. Likewise for Fannie Mae, which fell 41% in 2007 and more than 95% this year. Home Depot Inc. has lost 33% and roughly 8% in the past two years, respectively.

On the bear side, however, the performance of the ten stocks likely shorted by contrarians have fallen 47% compared to a 43% decline for the global market, Mr. Buckland noted, adding that this and more has been given back on the bull picks.

I'm not into mechanical strategies but this one clearly hasn't done well in the last decade. This sounds somewhat like the Dogs of the Dow strategy, which actually has a decent track record.


No Response to "Good note on contrarian investing"

Post a Comment