Buying stocks: Is it time to get greedy?

Why contrarian investors see opportunity amongst chaos

“Buy when there’s blood in the streets” is an old phrase in investing – and the blood isn’t symbolic. Baron Rothschild, a nobleman and member of a prominent banking family, made this comment following the Battle of Waterloo, where tens of thousands of people were killed. Napoleon was ousted as emperor of France – and Rothschild made a fortune investing during the panic that followed.

Fortunately, the trauma that hits the financial markets these days is usually less about carnage and more about corporate crises, recessions, unemployment, debt and natural disasters. But even taken less literally, the effect is the same: when things go wrong, investors run screaming from the scene as if it were a flaming battlefield - except for a few keen contrarian investors who see chaos as an opportunity and run right toward it. In fact, this scene of chaos is exactly what some experts say we’re seeing in the U.S. markets right now. So is it time to buy in? Here we look at the facts behind this long-held fundamental of the financial markets.

The contrarian club

Successful contrarian investors are not hard to find. Just look at the most recent Forbes list of the world’s billionaires: Warren Buffett at No.3, George Soros at No.46, Carl Icahn at No.61. These ultra-rich investors are famous for taking huge positions in tough market situations – and coming out on top.

Let’s take Warren Buffett. He’s the Babe Ruth of the investing world; the super-rich superhero every investor looks up to. His simple rule for investing? “Be fearful when others are greedy, and be greedy when others are fearful,” he told The New York Times in 2008. This is why Buffett has famously bought and profited on stocks that other investors wouldn’t touch at the time.

Fashion forward investing

The type of investing that contrarians practice is called ‘value investing’, and it works a lot like the fashion world, where those who are able to nail a trendy new look before it hits all the stores are applauded for their intuition. Going against the crowd can work in investing too. The reason for this is that market sentiment – how the general market feels about a stock, the economy and the prospects for investing in general - is a lagging indicator.

So just like in the world of fashion, where something shown on the runway may take months or even years to trickle down to the general public, in investing, it’s information and reaction that move more slowly than more fundamental factors such as employment and economic growth. This means that what the public feels is hot may be a long way off from what’s being modeled during Paris Fashion Week. By the time you buy your first pair of skinny jeans, the fashion world is already sooo over them.

Furthermore, at some point, all fashions are entirely written off as something no one should ever be caught dead wearing, and they’re marked down and relegated to the sales rack. The price drops simply because no one wants them anymore. This is exactly what happens in the stock market when long-term economic problems or corporate disruptions leave investors saying they wouldn’t be caught dead owning that stock. This very disapproval is why contrarian investors are often derided for the stocks they buy. But in reality, they may know something no one else does: the baggy jeans no one else is wearing are great for hiding a very thick wallet.

What not to wear

So how do you know when the time is right to strut your stuff in the market? Here’s where things get a little tricky...because great investors don’t just buy anything when the markets are depressed; they buy companies that they believe virtually cannot fail. So just like some fashions will never make a comeback (we can hope), some stocks plunge for a good reason, and therefore never recover. These are not the stocks contrarian investors gravitate towards.

What contrarian investors are essentially looking for are designer classics on the clearance rack. You see, contrarian investors are looking for the same kind of value as the classic white shirt - the kind that defies trends and lasts for the long haul. This value is also found in the great companies in which the contrarian investor invests...only like any good shopper, she seeks to buy on sale.

How to tell the difference

Trying to stay ahead of a trend carries considerable risk, both in investing and in fashion. When everyone else has deemed certain stocks untouchable, it can be very hard to determine which stocks are being unfairly ostracized and which ones are never going to be worth your money ever again.

Case in point: the major financial blow that hit the United States between 2007 and 2009 did put many powerhouse companies under. The trick for contrarian investors is to see through what other investors are doing, saying (and tweeting) and do the research to determine whether the crowd really is wrong. This is why good contrarian investors don’t put an immediate buy order on every stock that takes a plunge. First, they need to find out why other investors are running from it, and whether it’s because the stock has fallen out of fashion or has irreparable financial seams.

Staying ahead of the trend

What makes investing so hard is that there are so many factors to consider, not the least of which is the effect market participants can have on stock prices. And whether you succeed or fail in beating the market can really affect your rep.

You see, contrarians are the cool, fashion-forward folks who aren’t afraid to stand out because they believe they are ahead of the curve. When they’re right, they become celebrity investors - the divas of the investing world. But when they’re wrong, watch out. It’s like walking around in mom pants, fanny packs and scrunchies – a definite ‘don’t’.

And while contrarian investing may make sense in a renegade sort of way, remember that choosing great stocks takes time, effort and practice. Staying ahead of the latest trend is never easy - and losing money is never in style.

 

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