When everyone thinks alike, everyone is likely to be wrong.
These ten words embody the essence of contrary investing. Bubbles and panics have been a part of the financial landscape ever since people have been buying and selling. The South Sea bubble, Tulipmania, the Roaring Twenties, the commodities boom of the ‘70s, the dot-com boom, and the recent housing bubble all have this in common: excess leverage creates excess demand for and production of some particular good. After the bubble deflates, the excess capacity needs to be re-absorbed into the economy. A recession or depression inevitably follows.
Marx saw these booms and busts during the 19th century as proof that capitalism is self-defeating and must inevitably be replaced by a centrally planned economy, not realizing that the central planners could be just as susceptible to group-think, booms, and busts.
But people like to fit in. They are quick to conform and slow to differ. And because our minds are so adaptable, just repeating the conventional wisdom a dozen or so times a day will make you come to believe it.
Three years ago all anyone wanted to talk about was China, China, China. A five-year plan and leadership change later, their market has contracted 20%, and no one wants to talk about China, with its billion increasingly sophisticated consumers. Last year it was Apple, Apple, Apple. Now, a moderate earnings report and product launch behind it, the stock is down 35% and no one wants to touch it.
The crowd is most enthusiastic when it should be cautious, and is most cautious when it should be enthusiastic. Contrary thinking can be lonely and require great patience. But good returns are the best revenge. If you’re thinking of going against the crowd, you’ll have to think hard.
Douglas R. Tengdin, CFA
Chief Investment Officer