From a contrarian investing view, everyone remains bearish despite a market that corrected all of last year. I polled my Twitter followers recently to take their pulse on the market.
Lance Roberts Tweet
Of the 1280 votes cast in the poll, roughly 73% of respondents anticipate the market to be lower throughout 2023. That view also corresponds with our sentiment gauge of professional and retail investor sentiment, which, while improved from the October lows, remains depressed.
Net Bullish Sentiment vs S&P 500
More importantly, investor allocations, particularly among professional investors, remain extremely light, suggesting a much higher level of caution. The following is the 4-week moving average of the National Association of Investment Managers bullish index. While the reading of 25.04 in October coincided with the market low, the current reading of 48.16 remains bearish.
NAAIM 4-week Avg vs S&P 500 Index
As Bob Farrell’s Rule Number 9 states:
“When all the experts and forecasts agree – something else is going to happen.
Asa contrarian investor, excesses are built by everyone betting on the same side of the trade.When the market peaked in January 2022, everyone was exceedingly bullish, and no one was looking for a 20% decline. Sam Stovall, the investment strategist for Standard & Poor’s, once stated:
“If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”
Today, everyone remains bearish, suggesting the possibility of the market doing something no one expects.
The Art of Contrarianism
As we have often discussed, one of the investors’ most significant challenges is going“against”the prevailing market“herd bias.”However, historically speaking, contrarian investing often proves to provide an advantage. One of the most famous contrarian investors is Howard Marks, who once stated:
“Resisting – and thereby achieving success as a contrarian – isn’t easy. Things combine to make it difficult;including natural herd tendencies and the pain imposed by being out of step,particularly whenmomentum invariably makes pro-cyclical actions look correct for a while.
Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves against you –it’s challenging to be a lonely contrarian.”
As noted, a majority of investors remain bearish. There are certainly ample reasons to BE bearish:
- The Fed is remaining aggressive on monetary policy.
- Central banks are reducing liquidity to markets.
- Inflation remains problematic.
- Earnings remain elevated.
- The economy is slowing.
- Consumers are running out of savings.
We certainly agree with the more dismal outlook and continue to suggest that investors should be more cautious in their portfolio allocations. However, this is also the point where investors make the most mistakes. Emotions make them want to avoid the risk of loss.
Given that many investors have never witnessed a“bear market,”the current bearing sentiment is unsurprising. The increased price volatility, and subsequent decline in prices, created a substantially higher level of instability. That instability creates “fear” and drives investors to the behavioral bias of “loss aversion.”
Periods of Low and High Volatility
That increased volatility weighs on investor sentiment leading to poor investment decision-making and, ultimately, poor outcomes.
However, if the most fundamental premise of investing is to “buy when everyone is fearful,” investors may again be missing the contrarian opportunity.
With the market negatively positioned, the contrarian trade is an expectation of the unexpected.
- What if the markets have discounted an economic slowdown?
- What if earnings remain stronger than currently expected?
- Could the Fed reverse monetary policy?
- Have valuations declined enough?
The fundamentally bearish arguments of valuations, earnings, a Fed policy mistake, and a recession are certainly viable outcomes.
However, given that “everyone” is already expecting those outcomes, what happens if something else occurs?
Navigating a Contrarian Trade
As Bob Farrell’s Rule Number-9 states:
“When all the experts and forecasts agree – something else is going to happen.
Asa contrarian investor, excesses get built when everyone is on the same side of the trade.
Everyone is so bearish the markets could respond in a manner no one expects.
There are plenty of reasons to be very concerned about the market over the next few months. Given the market leads the economy, we must respect the market’s action today for potentially what it is telling us about tomorrow. Therefore, there are some actions we can take to navigate for whatever path the market chooses.
- Move slowly.There is no rush to make dramatic changes. Doing anything in a moment of “panic” tends to be the wrong thing.
- If you are overweight equities, DO NOT try and fully adjust your portfolio to your target allocation in one move.Again, after significant declines, individuals feel like they “must” do something. Think logically about where you want to be and use the rally to adjust to that level.
- Begin by selling laggards and losers.These positions were dragging on performance as the market rose, and they led on the way down.
- Add to sectors, or positions, that are performing with or outperformingthe broader market if you need risk exposure.
- Move “stop-loss” levels up to recent lows for each position.Managing a portfolio without “stop-loss” levels is like driving with your eyes closed.
- Be prepared to sell into the rally and reduce overall portfolio risk.You will sell many positions at a loss simply because you overpaid for them to begin with. Selling at a loss DOES NOT make you a loser. It just means you made a mistake.
- If none of this makes sense to you, please consider hiring someone to manage your portfolio.It will be worth the additional expense over the long term.
“In good times, skepticism means recognizing the things that are too good to be true;that’s something everyone knows.But in bad times, it requires sensing when things are too bad to be true. People have a hard time doing that.
The things that terrify other people will probably terrify you too, but to be successful, an investor has to be a stalwart. After all, most of the time the world doesn’t end, and if you invest when everyone else thinks it will, you’re apt to get some bargains.“
Follow your process.
As an experienced investor and financial analyst, I have spent years navigating the complexities of financial markets, studying investor sentiment, and understanding the nuances of contrarian investing strategies. My insights stem from a combination of practical experience, in-depth research, and a thorough understanding of market dynamics.
In the article you provided, the author delves into the realm of contrarian investing, a strategy that involves going against prevailing market sentiments. Let's break down the key concepts and terms mentioned:
Bearish Sentiment: The prevailing sentiment among investors indicating a pessimistic outlook on the market's future performance. This sentiment is highlighted by various indicators, including polls, sentiment gauges, and professional investor allocations.
Market Correction: Refers to a decline in the market of at least 10% from its recent peak. Corrections are often seen as healthy adjustments in the market cycle.
Polling Investor Sentiment: The author mentions polling Twitter followers to gauge their sentiment on the market, indicating a method of informal sentiment analysis.
Contrarian Investing: A strategy that involves taking positions opposite to the prevailing market sentiment. Contrarian investors often believe that the crowd is wrong and that opportunities exist when sentiment reaches extremes.
Bob Farrell's Rule Number 9: This rule suggests that when the majority of experts and forecasts agree on a particular market direction, the opposite is likely to happen. It underlines the contrarian principle of going against the consensus.
Market Herd Bias: The tendency of investors to follow the crowd or consensus opinion, even when evidence suggests otherwise. Contrarian investors seek to exploit this bias by going against the herd.
Howard Marks: A prominent investor known for his contrarian investment philosophy. Marks emphasizes the importance of resisting herd mentality and maintaining conviction in contrarian positions.
Fed Policy: Refers to the monetary policy decisions made by the Federal Reserve, including interest rate adjustments and quantitative easing measures. These policies can have significant impacts on market dynamics and investor sentiment.
Economic Indicators: Factors such as inflation, earnings, GDP growth, and consumer sentiment that provide insights into the health of the economy and influence investor behavior.
Portfolio Allocation: The distribution of investments across different asset classes, such as stocks, bonds, and cash. Portfolio allocation decisions are influenced by investor risk tolerance, investment goals, and market conditions.
Stop-Loss Levels: Predetermined price levels at which investors sell a security to limit losses. Stop-loss orders are a risk management tool used to protect against significant downturns in asset prices.
Market Volatility: The degree of variation in the price of a financial asset over time. High volatility can create uncertainty and fear among investors, while low volatility may signal complacency or stability.
In conclusion, the article emphasizes the importance of contrarian thinking in navigating the current market environment characterized by bearish sentiment and heightened volatility. By understanding market dynamics, investor behavior, and contrarian principles, investors can potentially capitalize on opportunities and mitigate risks in their investment strategies.