The Aleph Blog » Blog Archive » On Contrarianism

On Contrarianism

With markets, it doesn’t matter what people say.  What matters is what they rely upon.

Face it, people have opinions, and when asked only the most cautious or prudent won’t give an answer.  Talk is cheap.

But money talks.  What will people or institutions risk some of their financial well-being in order to make money?

Turning points are exceptionally difficult to call with time precision.  Anyone can say that a trend is going to break for a long while before it breaks; the trick is to be able to make the change within a short distance of the inflection point.  I’ve done it a few times, but I have little confidence in whether I can do it regularly.


Now part of this is that if you predict enough things, you will have some right ones to point to.  I am obviously picking and choosing here, but when I made these predictions, there was a method to my madness.  I am not like Cramer, who makes predictions every day.  I wait for points where markets are out of kilter, and then I act, and sometimes predict.

Calling turning points is very difficult.  I want to offer two bits of advice to those to try to do so.

1) Look for situations where the yield is unsustainable on the high side or on the low side.


  • Earnings yield too low during the tech bubble.  Also workers were relying on stock to rise, because they were getting much of their pay through options.
  • Net yield on much residential investment real estate negative in 2005-7, without even factoring in maintenance costs.  When someone is relying on price appreciation in order to break even something is wrong.
  • Toward the end of the commercial real estate bubble, the same was true.  Equity investors began to rely on price appreciation in order to break even.
  • When spreads on high yield blew out, at its worst the market was assuming that half of all high yield issues would die, with low recoveries.  Even the Great Depression wasn’t that bad.  The same was true in a faint echo for BBB Corporates.
  • During the recent bottom in March 2009, high quality companies could be bought for less than their net worth and at earnings yields unseen since 1973-74.

2) Look for a qualitative change when you think we might be near a turning point.

  • Chatter changes at/near turning points.  Certainty gives way to uncertainty.  Uncertainty gives way to worry.  Worry gives way to panic.  In October 2005, Googlebots that I created tipped me off to the change in the residential real estate markets way ahead of most parties.
  • Inflection points tend to be times of stasis as far as economic variables go, but confusion in terms of chatter.  During the tech bubble in early 2000, the chatter became decidedly less certain.

Inflection points are times of change, and chatter should reflect that.

Coming back to contrarianism, ask yourself, “What are people relying on to be true, that may not be true?”  That is what it means to be a contrarian.  Mere disagreement means little.  Where have men placed their bets?  Betting against the consensus is what a contrarian does.

Portfolio Management, Quantitative Methods, Speculation, Stocks, Value Investing | RSS 2.0 |

4 Responses to On Contrarianism

  1. PaulinKansasCity says:

    Great post David. Have a great holiday weekend with your family

  2. Note: what do many governments, corporations, etc., now realize that they relied upon that has now disappointed them? Two things: a perpetual increase in leverage, and that they could lever pensions off of investing in the stock market and other risky asset classes.

    This is still a problem, but the full ramifications have not come to pass yet. There is a theme for 2010.

  3. Bob_in_MA says:

    The perpetual increase in leverage has been going on here for 30-40 years, the full ramifications for a reversal of the process would seem pretty bleak. But also hard to predict.

    Oh, well. I’ll go sit in front of the fire and read my Christmas presents…

  4. Mike says:

    I like what you have to say and have been in on most of the turning points you listed. Late on a few and early on a few but there for the most part. Good blog, I like it. I clicked on the link and Cramer came up. This guy definitely had one too many market prediction!


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.

Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

 Subscribe in a reader

 Subscribe in a reader (comments)

Subscribe to RSS Feed

Enter your Email

Preview | Powered by FeedBlitz

Seeking Alpha Certified

Top markets blogs award

The Aleph Blog

Top markets blogs Bull, Boards & Blogs

Blog Directory - Blogged

IStockAnalyst supporter

All Economists Contributor

Business Finance Blogs
OnToplist is optimized by SEO
Add blog to our blog directory.

Page optimized by WP Minify WordPress Plugin