Monday, November 23, 2009

Contrarian Thinking

“Nevertheless, clearly there have been periods when the crowd and the consensus is right, particularly in extended bull markets, contrary opinion seems to be of greatest value at market extremes (lows and peaks).” - Steve Leuthold, View from the North Country, November 2009

Steve Leuthold is one of our favorite analysts and we also happen to own his fund, the Leuthold Core Investment Fund, in many of our managed accounts. I believe that his views on the consensus are right on the button. Value investors are always looking to invest differently from the consensus, but sometimes doing so results in missing out on large investment gains easily available through momentum investing, the very definition of investing with the consensus. I thought it would be an interesting exercise to list out a few of the consensus views of today’s investors:

• The economy moved from recession to expansion sometime in June or July.

• The dollar is in a secular (long-term) downtrend.

• Economic growth in the developed world will be subject to “the new normal,” meaning that it will be significantly lower than the historical averages for some time to come.

• Economic growth will be led by emerging markets, especially China, as opposed to developed countries like the U.S. and Japan, England, or the Euro zone.

• U.S. consumers will spend less and save more as they repair their personal balance sheets over a period of years.

• The Federal Reserve will not raise interest rates for the foreseeable future.

Because these are consensus views, investors have presumably priced them into today’s security prices. We happen to subscribe to the consensus view at the moment, but we are also on the lookout for those opportunities that occur when the consensus is wrong. As Leuthold says, contrary opinions have the greatest value at market extremes, but I don’t think we are there quite yet. Even so, we are currently hedging the consensus view with a variety of securities in the portfolio. The hedges won’t make us money while the consensus reigns, but they are essential ingredients of sound risk management when markets are trending as they are today.