The stock market is a peculiar thing when sometimes good is bad and up is down. It’s enough to drive somebody who is casually watching it nuts. Many famous investors including Warren Buffett have made millions and in his case billions by betting against the crowds and observing “contrary indicators” as they are known.
The basic premise behind contrarian investing is that the crowd is often wrong and when they realize it, the push to correct themselves will push stock prices dramatically in the other direction. In one sense value investing is the essence of contrarian investing. These investors buy stocks that are not popular on Wall Street and wait for the crowd to catch on and bid these stocks up to their fair value.
When too many people love a stock or the market as a whole, it is actually considered a bearish sign since there is less fuel to push it higher. If everybody already owns the stock, who is left to buy? That is contrarian investing in a nutshell. This is one reason I think the market has a lot of upside potential at these levels. I previously wrote about all the gloom and doom forecasts for the market. You just don’t get these kinds of statements at market tops. For example in 1999, everybody seemed to love the market and bought into the “new paradigm” of the internet hook, line, and sinker. Of course a lot of Monday Morning Quarterbacks will tell you that they saw it coming from a mile away, but that is hogwash.
This brings me to an interesting fact that I stumbled upon recently. Barry Ritholtz is a sharp market follower and he mentioned that for once, Wall Street analysts as a whole seem to be bearish. For those of you who don’t know, this group is always too optimistic and routinely slap “Buy” recommendations even in cases when they personally don’t like the stock. So it is certainly newsworthy when they turn bearish. Evidently, for the first time since the mid-1990’s, fewer than 29% of stock ratings are now “Buys.” Wall Street analysts have never been good at making money, so this is a beautiful contrary indicator for the bulls. Once the economy improves and earnings growth accelerates, there are a lot of analysts who will backtrack and upgrade stocks, thus providing further fuel for the upside.
The timing of this isn’t an exact science, and neither is contrarian investing as a whole. However, history tells us that being on the other side of the crowd has proven to be immensely profitable for those with patience. Just ask Warren Buffett.
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