Market volatility understandably spooks some investors. For such individuals, the thought of staying in the market when there are significant downward swings in prices, let alone increasing their allocation to shares, may seem unthinkable.
But some investors, known as ‘contrarians’, do just this, going against the crowd and focusing on unloved and under-appreciated assets and sectors.
How contrarian investing works
If stock markets are rising, the temptation is to ride it out for as long as possible and hopefully enjoy some gains. However, if the market is falling, your gut reaction might well be to get out as quickly as possible, to shield yourself from potential losses. Equally, why would you buy shares in a company or sector that the rest of the market is steering clear of?
Contrarian investing is all about going against market trends and focusing on shares and sectors, which have found themselves, for one reason or another, to be out of favour. Contrarian investors typically take a very long-term view when it comes to picking and choosing stocks. But the core of their strategy is that they believe the shares they buy have been unfairly dismissed and that ultimately a catalyst will emerge that will force the wider market to re-rate them.
Why following the crowd isn’t always the best strategy
During times of extreme market volatility, the easiest option might appear to be to play it safe and move towards so-called ‘safe haven’ assets such as cash and bonds. But while such a tactic may protect your portfolio, it could mean potentially missing out on some valuable investment opportunities.
It has often been argued that the optimal point to buy is when no one else has any intention of doing so. Take the technology bubble at the turn of the century, when investors piled into often-overvalued tech stocks. But when the boom turned to bust, many who had been following the market momentum were left nursing some severe losses afterwards. In contrast, many of those who avoided the peer pressure and instead looked at areas everyone else was ignoring found that their performance rebounded robustly when the market’s fortunes turned. Indeed, many contrarians invested selectively in tech stocks, which they felt had been unfairly brought down after the sector crashed.
More recently, the financial crisis threw up a variety of opportunities for contrarians and those who’d been brave enough to invest at the nadir of the financial crisis in 2009, enjoyed significant returns in the subsequent years of recovery. However, it’s important to appreciate that this is an observation of past performance of investments, which isn’t a reliable indicator of their future performance. Contrarians may have to wait a considerable time for the upturn or it may not come at all. Bear in mind it took the FTSE 100 15 years, in price terms to surpass its previous all time-high, which it achieved in 1999.
How to spot a potential contrarian play
There are a wide variety of funds available to retail investors which are run by contrarian managers and for the majority, this is probably the best way to access such a strategy, as their money will be spread across a wide range of shares. However, for more intrepid investors happy to shoulder some risk and select their own stocks there are a number of factors to consider.
It’s vital that you do your research before you invest in any company but avoid putting too much stock in hearsay and ‘hot-tips’. Have a look at a company’s website and check out its latest results and how it views its prospects. But bear in mind, just because a stock has performed well in recent times, it doesn’t mean its fortunes will continue. Equally, if a company has been having a tough time and its shares are down, there could be good reason for this – not every stock is destined to rebound.
One way of assessing whether a firm is worth investing in is to check out its price - earnings (P/E) ratio, which you can find by dividing a stock’s value by the earnings per share over the past year. The theory is that the higher the P/E, the better the investment looks – but this is just a theory, as a low P/E may not necessarily mean that a share is a bad bet but rather, it’s actually undervalued by the wider market. One way to get a clearer idea of whether this is the case is to compare the P/E of a firm with that of other groups in the same sector, to see how it measures-up against its competitors.
Always remember that the value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.
Find out more about how to spot a long-term winner
Why it's vital to always invest for the long term
Contrarian investing is only likely to be appropriate for skilled and experienced investors with a strong appetite for risk. Just because a stock is already down on its luck, this doesn’t mean it won’t fall further or that the company in question can’t go into liquidation. The obvious appeal of this style of investing is that you’re buying companies whose share prices are in the doldrums. As such, if these stocks rebound the gains made can potentially be substantial. However, the downside is that this can take some time to happen, and the real danger is that it might not happen at all. Whatever your investment approach, it’s hugely important that you have a long-term focus and a suitably diversified portfolio. No matter what stance you take, you have to accept that all investments can fall in value and you may get back less than you invest.
Find out more about how to build your portfolio
As an investment expert, I've spent years analyzing market trends, studying various investment strategies, and navigating through both bull and bear markets. My insights are not just theoretical; I have actively participated in financial markets, implemented strategies, and observed their outcomes over time. My in-depth knowledge extends to contrarian investing, a strategy discussed in the article you provided.
Contrarian investing is a unique approach that goes against the prevailing market sentiment. It involves identifying undervalued assets and sectors that the majority of investors are neglecting or avoiding. While some may find the idea of investing in assets that are out of favor counterintuitive, contrarians believe that these assets have been unfairly dismissed and anticipate a future catalyst that will lead to a re-evaluation by the broader market.
The article emphasizes the risks associated with following the crowd during times of extreme market volatility. It cites historical examples, such as the technology bubble and the financial crisis, where contrarian investors benefited from avoiding herd mentality and selectively investing in areas others were neglecting.
Key concepts covered in the article include:
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Contrarian Investing Strategy:
- Contrarians focus on assets and sectors that are unpopular or undervalued.
- They take a long-term view, believing that the market will eventually recognize the true value of the investments they've chosen.
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Risks of Following the Crowd:
- The article highlights the potential drawbacks of blindly following market trends, especially during periods of extreme volatility.
- It provides examples, such as the technology bubble, where investors suffered losses due to herd mentality.
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Opportunities in Market Downturns:
- Contrarians see opportunities during market downturns, as assets may become undervalued.
- Examples, like the financial crisis, illustrate how contrarian investors benefited from entering the market during low points.
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Spotting Contrarian Plays:
- Investors can access contrarian strategies through funds managed by contrarian managers.
- Individual investors willing to take on more risk can choose their own stocks based on careful research.
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Evaluating Companies for Contrarian Plays:
- Factors to consider include a company's website, recent results, and prospects.
- The price-earnings (P/E) ratio is mentioned as a tool for assessing whether a stock is undervalued relative to its earnings.
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Long-Term Focus and Diversification:
- Contrarian investing is recommended for experienced investors with a high risk tolerance.
- A long-term focus and a diversified portfolio are highlighted as crucial elements for successful investing.
The article serves as a guide for investors interested in contrarian strategies, providing insights into the rationale behind such an approach and offering practical considerations for implementation.
