One of the more difficult things to do in life, and especially finance is to be a contrarian. It can be hard to stand out against the crowd. What I’ve found is that more often than not, going against the grain is the more successful path in life. When it comes to investing, that is really the only way to make a lot of money when you think about it. I’ll explain why shortly, but first lets talk about conformity and the misconceptions it creates among people.
Conformity experiments have shown just how delusional a crowd can become. If you go to a public place, say for instance a bar, and find a door to a backroom where live music may be played on some nights. Let’s assume on this night for whatever reason, there is no band booked to play in the entertainment room, and thus no reason to go behind the door. If you and a few friends form a line at the door, on a majority of occasions, other people will start to line up behind you, forming a cognitive bias that just because other people are waiting in line, there must be something behind the door worth waiting for. As more people join in line waiting, even more of the people in the bar are persuaded by social curiosity to join in the line, leading an entire crowd of people to develop the wrong conclusion about the situation.
I fell victim to this myself a few weeks ago when going to a sports event. When walking up to the gates, I noticed that there were 3 entrances. The entrances on the left and right had long lines formed with people waiting to go through security. The middle entrance, which was also staffed with security was completely empty and had no line. The middle entrance was not any different from the left and right entrances, except for the fact that there was no line to walk up to the security. Clearly, I would have been much better off just walking through the middle gate. Instead, conforming to society and accepting that the crowd had ‘gotten it right’ about the situation, I went to stand in line behind dozens of people like a complete fool. The crowd was wrong, and I was wrong for following the crowd. It wasn’t until my wife pointed out that the middle gate was the same as the other two gates that we got off the line and went straight through to the security checkpoint. She was a contrarian, and got us in 20 minutes faster than the crowd would have.
In fact, when we were leaving the venue later that night, I pulled out of the parking lot and into the long line of traffic from all of the people trying to leave the stadium. Again following the crowd of fools, I went into the left lane which was veering left to exit onto one highway. The right lane being completely empty, I assumed wrongly that there must have been some reason for why you couldn’t drive in that lane, which veered off to the right. After all, the traffic officers put some cones up to try and help the flow of traffic, which made it somewhat confusing to me, and obviously to the rest of the crowd also. My stepdad, who was in the passenger seat told me he was pretty sure I could exit with the right lane. I tried it, and sure enough we were on the exit ramp away from the stadium, avoiding the crowd. Everyone in the crowd was probably sitting in bumper-to-bumper traffic for at least 30 minutes.
In investing, going with the general consensus may be the less painful way to generate returns over time. But the big returns come from finding situations where the entire crowd is wrong, and making a bet against the crowd. Being a contrarian allows you to take advantage of the general population’s ignorance. Often times, crowds are built on trust. After all, if everyone is investing in something it must be for a good reason, right? WRONG.
Was the market right to be pricing mortgage-backed securities above par directly prior to the bursting of the housing bubble in 2008? Was the market correct to assume that inflation was transitory last year? Did the markets or the general consensus get it right when they expected the dotcom boom to be a long-lasting windfall for any business with a ‘.com’ at the end of its name? - Of course not.
That is why the expression ‘the market is always right’ is completely asinine. As a contrarian, I would argue the market is basically always wrong. If you think about it for a moment, if the market was always right, you could never actually make any money as an investor. If the market was always right, good investment opportunities by default would never be available. A great investment opportunity only comes when an asset is mispriced because the crowd has gotten the completely wrong idea about a business, industry, demographic, or societal trend.
Here is the YTD chart of Netflix, a clear example of where the crowd led investors to get something completely wrong. Priced at $600 per share at the start of 2022, Netflix was once considered one of the most stable blue-chip stocks on the market. Now, everything is always much more easily recognized in hindsight, but going back to last year, it is clearly obvious that much more competition was going to become a hinderance on Netflix at some point. But the crowd got the story wrong, underestimating the importance of good content as a means of keeping the consumer’s attention. The reality is the crowd will probably have gotten the Netflix story wrong on both occasions - the run-up of the stock to $600 and its elevation at that high price for quite some time, and the over-selling of the stock down below $170. The contrarians who sold Netflix short were able to make a ton of money this year by placing a bet against the overwhelming majority.
Here are some other examples of stocks in the past 12 months where the crowd got it completely wrong. A key note here, I tried to stick with stocks most-supported by the analysts on CNBC, who are the leaders when it comes to forming ‘the crowd,’ and I really tried not to include any meme stocks or anything mostly associated with gambling:
This is what happens when you follow crowds in finance. That is why it is so important to do your own work. Don’t get me wrong - its important to consider the perspectives from other investors and keep an open mind. But buying a stock just because a CNBC contributor recommends it causes for debacles like the stocks shown above. All of the CNBC-regulars loved all of these stocks last year, and conformity from investors caused massive pain amongst the crowd. Crowds are wrong much more often than they are right, and developing cognitive biases is one of the bigger downfalls for most investors. Never follow the crowd in finance - be a contrarian.
If we look at where the investor crowd has formed in the past few months, we see all of the ***holes have moved into the US Dollar. I talked about this in depth on the last edit, so I won’t go too much further into this. But one point I should make clear…If the entire crowd has already piled into an asset, that should be a clear indication that the price of the asset has very limited upside from here.
Take Apple as an example. Apple, being perhaps the best company in the world, has become a staple stock in a large majority of ETFs and mutual funds, and serves as a backbone in many investors’ portfolios. Now sure, I expect Apple, over a long time horizon will continue to provide value and reasonable returns for shareholders. However, is there really much upside left in the short-term? Of course not. Forgetting the macro picture in the markets for just a second, assume we knew nothing about the economy, interest rates, strength of the consumer, and so on. Everyone already owns Apple. So who else is going to come in and buy the stock in a major way? There just simply is not enough money on the sidelines, not already involved in Apple for the stock to see major flows from here. Sure, Apple will be buying back its own stock, but there are no money managers left to come in and buy for the most part. So the short-term upside is clearly limited.
Turning back to the US Dollar - Sure, the US Dollar Index could continue to rally from here. But the upside clearly has to be limited, because everybody is already in the trade. A lot of money managers have gone to cash as a significant portfolio holding during these times of uncertainty. There just isn’t much money, at least from where I am standing, that can come in on this trade at this point. That is why gold’s downside is quickly diminishing, and gold remains a great buying opportunity here. Of course, this all makes me a contrarian.
Sticking with the stagflation narrative, where a slowing economy will be coupled with higher inflation for the foreseeable future, also makes me a contrarian. Of course, all of the economic data which keeps getting released supports that thesis, yet the crowd still stubbornly refuses to come over to my perspective.
Here is the notable economic data out this past week. I covered it all on this week’s podcast, linked below:
The average purchase price of homes came in just 0.1% higher, much worse than the expected 0.8% gain on the month. The housing sector has really come to a major slowdown, which has a great impact on economic activity since so many people are employed in that industry.
Despite the slowdown in housing prices, home prices still remain stubbornly elevated, as shown in the data below:
The 18.6% number represents the change in price of single-family homes over 20 different metropolitan areas year-over-year. If housing prices are 18.6% higher year-over-year, and housing costs are 1/3 of the entire CPI, why does the CPI only show the inflation rate to be 8.5%? Clearly, the government is rigging the data to completely understate inflation. That is why instead of measuring rent prices, the government created a survey which gathers ‘owners equivalent rent,’ which gives a false measure of the real increased costs of owning or maintaining a home, along with giving inaccurate measurements of the rise of rent prices across the housing market. Yet the crowd continues to use the CPI as a tool for measuring inflation.
The two positive economic data-points that came out this week were the JOLTS report and the CB Consumer Confidence Index. Half of the job openings are fake as I’ve explained in the past, and the job openings that are not fake are low-paying secondary work, such as retail, bar and restaurant jobs with low wages for people who can’t make ends meet on one salary anymore.
Consumer confidence is most likely associated with the lower gas prices on the month, but mostly associated with the forgiveness of $10,000 in federal student loan debt, which will affect approximately 46 million people. That of course will increase demand for consumer discretionary spending, which will put upward pressure on inflation.
Most importantly for this week, we got the August NFP report, where private sector jobs increased by 315K jobs. Take note with with the slightly better-than-expected increase in payrolls, the unemployment rate still managed to tick-up to 3.7%. The reason for the divergence is obvious when we see where the 315,000 jobs were actually added:
These are all part-time jobs for the most part since a big chunk of the jobs were added in retail for the back-to-school season, as long as in restaurants and bars. Not good news for the economy which continues to weaken, as evidenced most prominently in Average Hourly Earnings m/m. For the first 8 months of the year, average hourly earnings have increased by 2.8% (4.2% on an annualized basis). This means costs for businesses are continuing to rise, putting more upward pressure on future inflation, but workers’ wages are not keeping up with the rising cost of living. Since inflation is officially 8.5% and unofficially through the stratosphere, the consumer is continuing to weaken, with even more inflation pressures in the pipeline. More evidence of that future inflation pressure is in the last two economic data-points we should take note of from this week:
Productivity is declining, unit labor costs are rising, meaning weakened business activity with more increases in production cost prices…stagflation.
Heading into a holiday weekend, stocks sold off into the Friday close, capping an UGLY week for the markets. The S&P 500 had a 6.5% decline in the past 7 days alone, and the bond market also saw sharp declines. I’ll get into that more next week. Enjoy the long weekend!
Best
Ryan Garzone
True North Market Research, LLC
truenorthinternationalpartners@gmail.com