Contrary investing for the 90s

Economic history is marked by a pattern of credit-driven booms followed by busts, a cycle described by Ludwig von Mises as resulting from artificial manipulation of the money supply by governments and banks. During a boom, low interest rates encourage borrowing and investment, leading to economic growth and inflated asset prices. This period of prosperity, however, is built on the expansion of credit rather than genuine wealth creation.

Investors must distinguish between fact and opinion, using the former to form their own views rather than simply echoing others. Monitoring key sources such as daily newspapers can offer insights into market trends and potential reversals, providing a real-time pulse of the market. A unanimous expert opinion on market direction often signals a turn.

Business magazines like Time and Business Week can also indicate trend shifts, especially when they feature cover stories on persistent trends, which often precede a reversal. These publications aim to sell, so they tap into prevailing sentiments, making them useful contrarian indicators when a consensus is reached. Best seller lists are another indicator; books that resonate with market sentiment often reach these lists at critical market junctures.

Public opinion polls are valuable tools for investors, offering insights into market sentiment that can serve as contrarian indicators. The principle behind this approach is that extreme consensus among investors often signals a pending market reversal. For instance, when bullish sentiment in polls exceeds 80% or falls below 20%, it suggests that the market may soon move in the opposite direction.

This is because a unanimous market view implies limited remaining capital to sustain the trend. However, it's advisable to align with the prevailing trend until such extremes are reached, as trends tend to continue in their early and middle stages. In strong bull or bear markets, short-term corrections typically occur when consensus levels are between 20-30% or 70-80%, rather than at absolute extremes, indicating the need for careful judgment and consideration of additional market data.

Precisely timing market tops and bottoms is notoriously difficult, but investors can look for certain signs that suggest a market is nearing an inflection point. In a bear market, declining volume as prices fall indicates waning selling pressure. A volume spike on a price rebound may signal a bottom, alongside extreme pessimism in media, heavy insider buying, and a surge in put options.

Conversely, an increase in volume at price peaks can hint at a top, as can euphoric media and analyst sentiment, insider selling, and a rise in call options demand. While no indicator is foolproof and technical analysis can give false positives, using these signals can improve investment timing and returns. Objectively assessing market internals and sentiment is key, avoiding the common pitfalls of following crowd psychology.

Mutual funds offer investors several benefits, including diversification, lower costs, professional management, flexibility, and ease of access. They can follow aggressive or conservative strategies. Aggressive funds focus on high-growth companies, while conservative funds invest in established firms with steady dividends.

A contrarian mutual fund approach involves investing against current market sentiment. Contrarians invest in aggressive growth funds when the market favors high dividends and in conservative funds when the market favors rapid growth. This strategy aims to buy low and sell high over market cycles.

Contrarian investing involves going against market trends, buying when others sell and selling when others buy. This strategy can be applied in various ways. One method is to invest in smaller, high-growth companies during times of market pessimism and sell during bullish periods, accepting short-term volatility and diversifying to manage risk.

The stock market crash of October 19, 1987, known as Black Monday, saw the Dow Jones Industrial Average plummet by 22.6%, marking the largest one-day percentage decline in history. This event erased approximately $1.

71 trillion in market value globally. While computerized trading systems and portfolio insurance strategies were initially blamed for exacerbating the sell-off, deeper economic factors played a crucial role. Leading up to the crash, the U.

S. Federal Reserve had tightened monetary policy, leading to higher interest rates that made stocks less attractive compared to other assets. This shift prompted investors to rebalance their portfolios away from equities.

Today's income investors, more financially savvy than their predecessors, are acutely aware of inflation's detrimental effects on returns. Many organizations are still grappling with significant debt from before the 1987 crash, limiting their financial flexibility. Approximately 8 percent of the average American's paycheck is dedicated to interest payments, highlighting the burden of debt.

Additionally, trends such as an aging global population, a shift towards balanced government budgets, and the high interest rates of the 1980s are influencing investment behaviors. These factors suggest a growing attractiveness of government bonds over the next two decades, with contrarians eyeing periods of credit crunches as prime buying opportunities. Zero coupon bonds, offering locked-in returns barring issuer default, emerge as a compelling option amid falling interest rates.

Investing in utility stocks and real estate investment trusts (REITs) can be effective for hedging against inflation. Utility stocks are considered good value, with lower price-to-earnings ratios and higher dividend yields compared to industrial stocks, suggesting they may be undervalued. Their essential services and potential for growth with increasing electricity demand make them attractive for long-term profit and dividend growth.

Inflation is a natural occurrence in market economies, and investors can plan for it by investing in asset classes that outperform inflation. Common anti-inflation assets include gold, commodities, real estate, and Treasury Inflation-Protected Securities (TIPS). Gold has consistently retained purchasing power and marketability even when paper currencies have failed.

However, gold prices can fluctuate widely, and investors should focus on the underlying inflation cycle rather than specific price predictions. Shares of gold mining companies and silver are also options, with contrarian signals helping to time entries and exits. Foreign currencies, particularly Swiss Francs and Japanese Yen, have been used as classic inflation hedges.

Leverage in investments means using borrowed funds to amplify buying power and potential returns. Investors can control larger positions than their capital alone would allow by borrowing money, often using the investment as collateral. For instance, margin accounts let investors deposit a fraction of the total value to buy more shares than their funds would permit.

While leverage can significantly increase profits if the market moves favorably, it also magnifies losses. To manage the risks, experts recommend only investing what one can afford to lose, maintaining a solid margin buffer, setting strict loss limits, and staying emotionally detached from market swings. Diversification is crucial, with a suggestion to limit exposure to no more than 20% of capital in a single speculative trade.

In an era dominated by experts and gurus, it's tempting to follow their advice blindly. However, it's crucial to engage in critical thinking and assess the logic behind their recommendations. Experts can offer valuable insights, but it's important to consider whether they have considered all factors and if their advice aligns with your own analysis and priorities.

Contrary thinking in investing means resisting the allure of popular opinion and instead relying on one's own critical analysis. It's about being a trendsetter, not a follower, and involves challenging the status quo, being skeptical of experts, and looking beyond the obvious. This approach requires controlling emotions like fear and hope, and being willing to admit and correct mistakes promptly.

While it's easier to find security in crowd-thinking, success often favors those who remain detached amidst widespread irrationality. Contrarian investing principles apply broadly in markets driven by human behavior, where groupthink has been prevalent for centuries. Watching public opinion closely is key; when analysis suggests the market has lost its sanity, acting contrary to the consensus can be wise.