Understanding Counterpoint

If contrary thinking is so good, why doesn't everyone do it? In the first place, if everyone did it, then it would not work because there would be fewer panics and speculative orgies. Second, it can be very uncomfortable to be wrong and contrary at the same time: the humiliation of going against the crowd when the crowd is right and that can happen is devastating. And third, much of our training and socialization teaches us that the majority is right, or at least, Is contrarian strategy profitable? There is some indication that former loser stocks perform better than winners, but is this because they are riskier? And what about the transactions costs of a short-run contrarian strategy? The quantitative evidence on these questions, as in most investment documentation, seems to depend on the case the researcher wishes to support more than the case itself. Nowhere is the adage, "if you torture the data long enough, it will confess to anything," more clearly observed than in the examination of investment techniques. But a mixture of contrary instincts and investment skills seems to be a part of most investors we admire.

Finally, is contrarian strategy inconsistent with the concept of market efficiency (see Market Efficiency)? The efficient market hypothesis (EMH) in its strong form contends that security prices are always correctly assimilating information. Today, investors generally expect that the weak form of EMH is operative, which means that sometimes it is possible, with generally available information, to gain an advantage over other investors. Contrarians look for these small opportunities by noting where the consensus seems to be clustered and they examine the other, independent alternatives.

Contrary thinking can be a challenge to assumptions that are so deeply embedded in our understanding of the world that we often do not even realize they are there. Three contrary questions in particular may be helpful in guiding us to contrary answers. Contrarians should ask questions like these that are often not even being considered.

The first is, why do investment markets assume that growth should be the sole objective of economic enterprise? Primarily, because of a fifty-year expansion in bull markets, but in most cases, the pursuit of growth comes with the possibility of volatility and risk. Stability and survivability can also, under some conditions, be worthwhile objectives. Contrarians are likely to value these features, which are considered valueless by other investors. Corporate control through proxy voting, for example, is often considered valueless and even a potential conflict for a manager in his client relations. And yet, in a merger or acquisition environment, proxy power is quite valuable: some studies have estimated it at about 15% of total share price. Contrarians might be quicker to identify these underlying mispricings.

Second, we are raised on the notion of continuous time. Nobel Laureate Robert Merton (see Risk Management) wrote a fundamental text with that idea in the title. We learn that time is a horizontal axis on a time chart with each unit of time connected to its neighbor and all units of equal space and importance time is continuous, time flows, time moves on, time in any one period is connected with any other period, time reveals trends. But in the physical world, time may be discontinuous and unconnected with any other time period sometimes coming in bursts, separate packets of information, unique in themselves. And investment time could be like that: Humphrey Neill wrote "sudden events quickly crystallize opinion." Our assumptions about time having a root in the past leading to clues about the future may be wrong.

Third, there is the built-in notion of an equity premium. After a fifty-year period of expansion, we take it for granted that equities produce higher returns, and we think that this is because they have higher degrees of risk. Are we prepared for the time when risk produces lower returns for equities? Or that on closer examination, risk itself becomes something other than volatility but risk of loss and risk of being knocked out of the game?