Contrarian Thinking Chris Mayer Contrarian thinking is another important ingredient to investment success. Running against the crowd often produces investment success… but not always. The essence of a contrarian investment approach is, as author Humphrey Neill memorably put it, "When everyone thinks alike, everyone is likely to be wrong." "Everyone" in Wall Street parlance usually means derisively "the crowd" or "the herd." Market lore is replete with tales of the madness of crowds and the follies of following the herd. Most people like to think they are not part of the multitude, yet by definition, most people are. Today, as we gaze back at a market peak that looks more magnificent with the passage of time, we have plenty of fresh evidence that contrary thinking is good for the portfolio and good for the soul. Contrary thinking in early 2000 would have saved you a lot of money. But that is the nature of markets. Booming markets foster illusions; bear markets pull back the curtain. Contrary thinking helps pull back that curtain before the crowd does--before it's too late. What everyone knows is not worth knowing, as the old saw goes. Yet the crowd is not always wrong. The great myth about contrarian thinking is that it consists of simply betting against the crowd. The art of successful contrary thinking is in its astute application. The great boom of the late 20th century was built on a lie. In retrospect, it is easier to see. Broadly speaking, the lie was simply that we could get something for nothing or that a new era had repealed the old laws of economics. In this aspect, the lie was probably as old as the oldest of human civilizations, told repeatedly over thousands of years. But the late-20th-century American bubble was perhaps novel in its size, scope and sheer ambition. Under this big tent thrived a circus of bad ideas--that stocks were less risky than bonds, that the art of central banking had become a science that could eliminate recessions forever and that stocks were always a good investment, no matter the price paid for them… All of these fallacies and more have their counterparts in the bubbles and booms of earlier epochs. There are new twists and variations on the theme, of course. Each historical episode is by nature a unique human experience, forever buried in the flux of time. Nonetheless, in its essentials, the late-20th-century boom had all the familiar markings of its siblings and cousins. Understanding the phenomenon of booms and busts is the beginning of successful contrarian investing. To do this, we'll need to look at broader trends in the financial markets. In particular, the relationship between capital, money supply and interest rates. Like a spider's silvery web, a pull or a tug on one thread sends telling vibrations throughout. The consequence of tinkering with any one is to upset all three. As a result, money supply and capital are often confused for each other, and low interest rates are viewed as a laudatory policy goal or achievement. The consequences, however unintended, are ignored. The important distinctions and roles each of these influences plays in a market economy are often neglected. This foggy view of capital results in repeated episodes of crisis. Wide-scale malinvestment, or investing capital in ways later prove to be unprofitable, is the defining characteristic of booms, caused by a disruption in that nexus between capital, money and interest rates. Crisis is the result of that later inevitable reckoning when such booms are found to be unsustainable. This boom-and-bust cycle is endlessly fascinating and instructive. We'll regularly look at the stock market, the bond market and the economy in general as we navigate our way through the perilous investment waterways of today's markets. And we won't hesitate to go against the crowd. | 
