Don’t Be a Lemming! (And Other Investing Wisdom)
Human beings are susceptible to blindly following conventional thinking until it takes them right off a cliff. That’s why our in-house experts give great credence to contrary investing, a method that entails bucking the herd mentality.
Contrary investing is the art of going against the crowd and the pressures of conformity. This mindset works in any sort of investment market because human nature is constant everywhere. The sad fact is, most people (and that includes investors) are lemming-like followers, not independent thinkers.
One independent thinker is Jim Pearce, chief investment strategist of our flagship publication Personal Finance. Jim strives for objectivity and right now he’s wary of the froth in today’s stock market:
“The skeptic in me can’t help but wonder if the stock market is overreacting to what at this point is little more than a lot of pie in a very high sky.
The unbridled optimism that has pushed all the major stock indexes to record highs can just as quickly be replaced by daunting pessimism if Trump fails to deliver on the ‘phenomenal’ changes to the tax code he alluded to last week, or backs off on his oft-stated goal to rebuild American’s roads, bridges and airports…
That’s why investors need to start thinking in a contrarian manner. Some of the stocks you feel most comfortable owning will be the same ones that will perform the worst when the market takes a tumble. Conversely, other stocks that have been abandoned by the herd could end up leading the market higher as their unrealized value becomes apparent.”
Tulipmania and the madness of crowds…
As we’re seeing right now with the post-election rally, most people move in groups. Consequently, they tend to buy after prices have already risen and sell after prices have already fallen. By following the advice of this article, you can learn to recognize the extremes of crowd behavior, and make investment plays against it.
Charles Mackay, in his 19th century classic economic book, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, aptly describes the tendency of investors to behave like lemmings. Consider his account of “Tulipmania”:
“In 1593, no Dutchman had ever seen a tulip. Their beauty and rarity caught the national fancy. In no time, they became ‘the rage’ as aristocrats flaunted the exotic flowers as symbols of power and prestige… Though supplies could be increased only as fast as nature allowed, demand for tulip bulbs accelerated at a fevered pitch.
Soon all tiers of Dutch society were swept up in a tulip-trading craze that peaked in the 1630s, selling ‘futures’ on crops not yet grown or harvested. In the end, crops of bulbs still in the ground were bought and sold so many times that the sales were called the ‘Wind Trade’ (as the speculative prices were being made up out of thin air). After the market crashed in 1637, bankrupting many, the era came to be known as ‘Tulipmania’ or ‘Tulipomania.’ ”
In the above passage by Mackay, substitute “tulip” for “mortgage securitization,” and you come to the sinking realization that nothing has changed over the last four centuries. To avoid getting sucked into similar investment fads, here are the top contrarian indicators that you should watch:
- The mainstream business press is repeating the same talking points about the same trend.
The talking heads on media venues such as CNBC often aren’t financial experts; typically they’re generalists and performers who glibly encapsulate the common consensus. For example, if a neatly coiffed pundit is warning of the imminent dangers of inflation, it probably means that inflation has already reached a peak and these fears are now overblown. Our strategists scrutinize the data and come to their own conclusions.
- A fundamentally strong company is unfairly getting beaten up in the press and by analysts, driving down its stock price to unjustified lows.
If a certain company is getting a lot of bad press for a misstep, sending its stock into free-fall, it could be a great buying opportunity. Take a look at the company’s fundamentals. If the company makes a good product that people will continue to need far into the future and its fundamentals are strong, you should consider making an investment. Bad press tends to be ephemeral. A disciplined contrarian investor is continually on the prowl for “out-of-favor” stocks.
- A fundamentally weak company is riding a wave of positive publicity.
The converse of the above rule also is true. People, with all of their irrationality, are what move markets. A company that’s benefiting from a lot of hyperbolic press coverage might have poor fundamentals and be ripe for a fall.
This dynamic is especially pronounced in the technology sector, whereby Silicon Valley companies announce sexy new gadgets that capture the fancy of consumers and local newscasts. Often lost in the gee-whiz coverage is the company’s unsustainable debt or lousy earnings prospects.
The beleaguered stock of wearable camera maker GoPro (NSDQ: GPRO), an erstwhile Wall Street darling, immediately comes to mind. Once all the rage, the company’s products now face harmful competition from bigger rivals.
- The mood of investors is persistently gloomy.
If the stock market is bearish and everyone is regarding stocks the way Superman regards Kryptonite, a new bull run may be imminent. When investors are unanimously gloomy, prices can only go up.
- The stock market is on a dizzying upward trajectory, fueled by euphoria.
Which brings us back to today’s Trump rally. When everyone and his brother is buying stocks and dishing out hot stock tips, it’s a clear sign that a top is near. Investors tend to buy when they anticipate the market will rise; they sell when they anticipate the market will fall. But if everyone is expecting prices to go up, odds are that everyone who intends to buy already has bought. So, who’s left to bid prices up? The Dutch learned this lesson the hard way.
Generally speaking, if you consistently buy during times of unreasoning fear, and sell during times of euphoric greed, you’ll do well.
Got any questions or feedback? Send me an email: email@example.com — John Persinos
This trader is no lemming…
Another man who thinks for himself is Jim Fink, chief investment strategist of Velocity Trader.
In fact, Jim developed his own proprietary investing system that made him rich… and now he wants to share his moneymaking secrets with you.
We recently opened up 100 spots to Jim’s top-tier trading service and we’re allowing folks to join at a fraction of the original price. The spaces are nearly full and we’re soon closing out access.