First and foremost, you should know one thing: the US economy and financial markets are not tanking. They are undergoing a massive transformation that not only offers investment opportunities, but also economic improvements that we haven’t seen in years.
Why and how will these opportunities and improvements occur?
I have written articles explaining this rebuilding process. However, these are one-offs. It would take a book to provide a thorough explanation. The problem is, when you watched “The Full Explanation” by John S. Tobey, CFA, your first (and last) thought would be, “Who is this guy? Why does he think he has the exact view Everyone else is missing? Phew!”
So how do I explain how to form and act on timely contrarian opinion when the popular trend seems irreversible? Let me try a different approach by describing what successful contrarian investing requires:
- First, gather knowledge beyond current affairs and institutional training. A particularly good source are the older, well-written books that use past events to uncover truisms. A real understanding can be learned without current news and feelings clouding the issues.
- Second, focus on investing. While investment developments and trends over time may show some similarities, the differences are always numerous. Also, what is important at one time may not be important at another. So stay curious, focus on developments and be prepared to change analytical approaches.
- Third, build rich experience. “Build” means experiment, adapt, develop and act. While investment environments are bound to change, experience provides a helpful investment sense – a form of intuition.
- Fourth, be innovative. When one believes that a potential contrarian shift is afoot, what can one do about it? A good strategy will likely be an approach that differs from the previous trend.
- Fifth, once a contrary point of view is taken, continue to test your thought process as new facts and events emerge. This will strengthen your resolve.
- Sixth, don’t fall into the always-opposite mindset. Being contrarian at the right time provides value. Being a perpetual naysayer doesn’t do it.
Key components of today’s contrarian view:
First, the Federal Reserve made a huge mistake by overriding the capital market’s key role in setting interest rates. Worse still, by keeping interest rates near 0% for a decade, the Fed “educated” investors into thinking that the Fed was doing a good thing, so today’s hike in inflation must be bad.
Second, there is a common misconception about inflation:
- What it is – erosion of paper money – not just rising prices
- How to measure them correctly – especially not relying on the highest moving 12-month number
- Your Benefits – Stock prices, earnings, and dividends are all based on non-inflation-adjusted numbers (so don’t use adjusted for inflation GDP growth as a measure of stock market strength/weakness)
Third, the news is almost entirely negative – what’s wrong and why does that mean a recession and stock market crash are inevitable?
As I mentioned in my last article, the rule applies: if “everyone” is negative, the bottom is here or near it.
Conclusion: Never bet against common sense
“Common sense” plays a big part in contrarian thinking because popular rationale is always lacking at lows (and tops). Instead, invented explanations are created to support the belief that things are not exaggerated.
A helpful sign that common sense is not at work is when you have an absolute feeling that the current trend will continue. (Even professional investors get these misleading sentiments at times like this.)