28 November 2005

Contrary to
“Contrary Opinion”

If you’re going to invest on “contrary opinion,”
just who are you going to be contrary to?

The theory of contrary opinion is appealing. The idea that average investors are usually wrong, operate more on emotion than reason, and often exhibit herd-like behavior is a compelling one that has large elements of truth.

Another variation is that professional fund managers aim, primarily, to match each other’s performance, so collectively they behave like lemmings — the classic example of self-destructive herd behavior. (“After all,” as Warren Buffett put it, “no individual lemming ever got a bad press.”) As a result, they exhibit herd-like behavior — offering the perfect “crowd” to bet against.

Wall Street is a favorite whipping boy, so this idea is a staple of investment newsletter marketing, implying the writer has some superior source of information.

Like all myths, the idea of contrary opinion has an element of truth. Legendary investor Bernard Baruch, for example, sold all his stocks while the crowd was frantically buying, shortly before the market crashed in 1929.

In the bear market of 1973-74, Warren Buffett was scooping up shares in the Washington Post Co., paying 20 cents in the dollar, while Wall Street was uniformly of the opinion that the stock “could only go lower.”

Jimmy Rogers became famous — and rich — by buying stocks dirt cheap in places like Portugal, Botswana and Malaysia at a time when foreign investing to an American was buying mining stocks on the Vancouver stock exchange. Some 20 years earlier, John Templeton loaded up on stocks in Japan when all the “crowd” knew was that “made in Japan” meant cheap and shoddy.

Yes, great investors usually go against the crowd. They usually buy when others are selling, and sell when others are buying.

But is there any cause and effect relationship between their actions and what the crowd is doing? Do you think these great investors ever check out what the average investor is up to — so they can do the opposite?

When he was loading up on the Washington Post Co., do you think Warren Buffett — whose idea of a group decision is to look in the mirror — gave a damn about what Wall Street or anyone else thought?

Put like this, the whole idea of contrary opinion is absurd.

Great investors make up their own minds based on their own — original — research. As a result of that, they’ll often do the opposite of what the average investor is doing.
But not always.

When George Soros cleaned up by shorting the pound sterling in 1992, he was far from alone. Currency traders know that when the minister of finance announces that his currency won’t be devalued, it’s usually a sure sign that the writing is on the wall.

In 1992, Soros was one of the “herd” of currency traders betting the pound was about to collapse.

What launched Soros into the limelight was that his profit was $2 billion! Compared to “just” the hundreds of thousands or millions that other traders made.

And if anything, the crowd was following him, not the other way around.

Who’s consistently wrong?

The other problem with the idea of contrary opinion is that who, exactly, should you be contrary to? Which class of investors — institutions, fund managers, investment advisors, newsletter writers, the “average” investor — is consistently wrong?

And if you’ve figured that out, how do you find out what they’re doing so you can do the opposite?

The market is made up of millions of people. There’s no way anybody can tell with any precision what they’re all up to — let alone what they’re thinking.

Investment “gurus” — whether major or minor ones — will often give the impression that they know. For example, you might read in the newspaper’s daily market round up of some analyst saying: “Institutional investors were piling into the market today,” or something similar.

How did he know that? We have no idea.

This is how it works. People want to know why something happened. In any case, reporting that the Dow went up 30 points or the euro was down 1 cent does not a story make.

So the journalist whose job it is to write this daily commentary flips through his Rolodex of contacts and selects a couple to call for an opinion. “What caused the market/IBM/the dollar to go up/down today?” is the kind of question he’ll ask.

The Analyst of the Day will give his explanation. And he won’t want to look like a dummy so if he doesn’t really know he’ll make something up.

I know this is how it works: I’ve been there, done that.

(The result, of course, is that the explanation given in, say, the Wall Street Journal can be the exact opposite of the one you’ll find in the Financial Times or Businessweek.)

And there’s the magazine cover “index.” Who hasn’t heard of the famous Businessweek cover announcing the “Death of Equities” — which ran in 1982, the year the greatest bull markets in the history of stock markets began.

Perhaps the Economist is trying to make the theory of contrary opinion true. Back in 1998 they ran a cover story titled “Drowning in Oil” — just as oil was bottoming. And a cover last December heralded the “Disappearing Dollar” — the exact opposite to what the dollar has done since!

It’s easy to see these were great “calls” — with 20/20 hindsight. But what about the other cover stories they ran that were right? They never get mentioned by proponents of the theory of contrary opinion. But you’d have to collate them first before you could rely on any publication’s consistent inaccuracy.

To try and figure out what “the crowd” is thinking or doing requires lots of research. And if that research is to be sufficiently complete to be accurate it’s unlikely to be available until a long time after it’s useful.

And maybe not even then. Historians are still arguing about the exact causes of the stock market crash in 1929 some 80 years after it happened.

Perhaps there’s some group of investors or opinion makers — “average” investors, fund managers, institutions, advisors, magazine covers, and so on — which gets it wrong most of the time.

But the reality is rather like a friend of mine put it about a certain investment advisor: “If only he was wrong all the time, I could make a bundle of money.”

Sad to say, if there are any shortcuts to wealth, the theory of contrary opinion isn’t one of them. — Mark Tier

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