Thoughts On Contrarian Investing & How Everything’s A Bubble

It’s our natural inclination to lean towards contrarian investing. After all, waiting on shares to increase 10% pa after year yearly result is slow, and what better way than to double your money by buying them in the half price sale during an fire sale?

The Case Against Contrarian Investing

Contrarian investing has the feeling of mimicry of amateur investors saying “Buy low, sell high” without having any way to work out what “low” or “high” is, other than based on historic cost of shares. One could say that the shares are priced lower because that’s what they’re now worth. For example, if you owned a company that lost all it’s contracts and could no longer trade, it would very well be worth less and this fact would in no way make it a bargain. In such a fictitious example, there would be no reason for the shares to ever regain their value if the company couldn’t get new contracts – which is an abstract way to describe what essentially happened during the COVID 2020 slump, though in this case despite all odds and a bleak outlook from economists and other people in the know (directors or such companies), the economy survived and share values went back up.

I think over the past few years there’s also been a lot of Winner’s Bias, whereby people who didn’t understand what they were doing, bought in the recent stock market slump, got lucky and used this success to mentally justify their skillful tactic of contrarian investing without proper analysis of value.

That’s the case against contrarian investing. Before we look at the case for it, I’d like to talk about “bubbles”.

Everything Is A Bubble

I’ve been giving some thought to markets, debt and the concept of value in an economy recently.

I started my line of thinking around the idea that we all have assets that are worth less than they are worth… Wait, what?! What I mean by that is, whenever there is a tradable asset for which there is a market (such as a house or shares), those assets have a value. That value is set by the most recent value of those traded assets. In other words, if you have 100,000 shares in CompanyX and CompanyX shares were recently traded on the market for $100 each, your shares would be worth $10m. However, if you were to try to sell all your shares in CompanyX, the volume of shares for sale would push the price down (think of a supply and demand diagram), so the total value of the company could never be as high as the market capitalisation based on the current share price.

This overvaluation is effectively a bubble and it happens in all markets. This overvaluation is often used to justify spending and offer backing for debt, which creates a debt bubble and a spending bubble. At this point it’s clear that we are always living in some sort of bubble which exists in various levels of bubble size, but how small could a bubble go before there is no bubble and we find an economy at its underlying value?

The answer to that is impossible for me to work out, but I suspect the answer lies somewhere in the value of the Net Present Value of essential goods and services produced throughout the country that can be afforded at the time without debt, plus the value of some non essential goods and services that can be afforded with debt where the debt can be serviced from trade of essential goods and services (I think that GDP value probably has too many intangibles to consider reliable and relies on debt from a bubble). The answer is clearly too complex to calculate and repudiable based on the method and purpose. In any case, it’s certainly too complicated to be used to calculate the minimum value in an asset without a bubble.

The Case For Contrarian Investing

We can see from this, that the world always operates in bubbles and that bubble can never go away due to the way supply & demand, asset values and debt work. Given this, contrarian investing could be considered the purchase of assets on the understanding that upon normalisation of conditions, the bubble will return to its previously inflated state and the assets will be worth significantly more. The gamble I suppose, is that the asset you invest in doesn’t fail or that the rate of bubble inflation isn’t slower than the rate of success of a more reliable investment.

Like every investment, I suppose it has to fit into the overall financial plan / strategy. Nonetheless, this thinking has paved the way for me to consider such an investing style in a different way.