Is being deliberately contrarian a strategy?
(Below is part one of our weekend blotter, we will publish the final part tomorrow)
Claiming that you are a contrarian is a double-edged sword. Investors, in all forms, love to hear diversified thinking that isn’t in line with the rationale of the majority of market participants. However, being contrarian for the sake of it, is often viewed as being intellectually weak. Taking the other side of the consensus doesn’t require a great deal of research. You are broadly taking the view that with everyone skewed in one direction, where are the new buyers or sellers to force asset prices into a new paradigm? Broadly, I do think it can be a flawed strategy at times because being the consensus does not necessarily make it wrong. If the intelligence used to form the view is sound and rigorous, the general acceptance of this thesis doesn’t necessarily discredit it.
Momentum has a lot to do with positioning and thinking becoming excessive. The broad mindset of the market is that conviction levels rise and fall with prices. The higher prices go, the greater the surety that a bullish scenario will continue. The more they fall, the belief grows that troubles will only get worse. Behavioral economists and group think advocates have a field day with this and this has created a mindset that being a contrarian has some merit. For me, there is more to it than this. As we know, some markets trend and some mean revert. Picking a top in US equities in the past several years has been a mugs game, especially when valuations and sentiment became excessive. However, those of you who used similar indicators for the USD, long duration US fixed income and crude oil have been rewarded. However, again, it is not that simple.
For the prices of assets to move to a higher or lower trading range, either hard prices or the valuations paid for assets, the fundamental outlook for these assets must be either improving or deteriorating. Otherwise, trading ranges or the current equilibrium will remain. Look at the US 10-year bond yield for example. Despite a reckless government spending program and a deteriorating fiscal outlook, an FOMC determined to lift cash rates every quarter and the prospect of a shrinking Fed balance sheet leading to even more supply, long duration yields have been stuck in broadly a 25bp trading range for months. So as yields have ticked up in the past 2 weeks, has anything fundamentally changed that will send interest rates for ten-year paper to levels not seen in five plus years. Is the economy going to accelerate from it’s current tax cut induced sugar high? The Fed and the market are roughly in alignment over the path of interest rates over the next 9 months (once a quarter between now and June 2019), so if this is the case, where is the interest rate shock? Inflation concerns, for the fourth year running, have proven completely overblown, not only in the US but globally. Wednesday’s UK inflation reading should confirm what the EU and US appear to be telling us that inflation globally has peaked. Tariff pressures / rhetoric is only going to get worse and while this could lead to spiking prices in the sectors effected, the initial response is growth negative.
This week will be filled with the aftermath of tragic natural disasters on the Atlantic Coast of the United States and South East Asia. Damage to Hong Kong and the Carolinas is extensive and will require a fiscal response. The Bank of Japan, despite rising rhetoric should prove a non-event but hawkish talk would boost the yen. The rest of the week is light for data. On Monday, EU CPI. On Wednesday, UK CPI and PPI, and the US reports on housing. On Thursday, New Zealand GDP. On Friday, Japanese Industry Activity, PMI’s of Japan, Germany, the EU, and the US are released, and Canada prints CPI.