By Howard Marks,
Author of The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor
Accepting the broad concept of contrarianism is one thing; putting it into practice is another. On one hand, we never know how far the pendulum will swing, when it will reverse, and how far it will then go in the opposite direction.
On the other hand, we can be sure that, once it reaches an extreme position, the market eventually will swing back toward the midpoint (or beyond). Investors who believed that the pendulum would move in one direction forever -- or, having reached an extreme, would stay there -- are inevitably disappointed.
On the third hand, however, because of the variability of the many factors that influence markets, no tool -- not even contrarianism -- can be relied on completely.
Contrarianism isn't an approach that will make you money all of the time. Much of the time there aren't great market excesses to bet against.
Joel Greenblatt: I've put it this way: just because no one else will jump in front of a Mack truck barreling down the highway, doesn't mean that you should!
Even when an excess does develop, it's important to remember that "overpriced" is incredibly different from "going down tomorrow."
Markets can be over- or underpriced and stay that way -- or become more so -- for years.
It can be extremely painful when the trend is going against you.
Seth Klarman: This is where it is particularly important to remember the teachings of Graham and Dodd. If you look to the markets for a report card, owning a stock that declines every day will make you feel like a failure. But if you remember that you own a fractional interest in a business and that every day you are able to buy in at a greater discount to underlying value, you might just be able to maintain a cheerful disposition. This is exactly how Warren Buffett describes bargain hunting amid the ravages of the 1973 to 1974 bear market.
It can appear at times that "everyone" has reached the conclusion that the herd is wrong. What I mean is that contrarianism itself can appear to have become too popular, and thus contrarianism can be mistaken for herd behavior.
Finally, it's not enough to bet against the crowd. Given the difficulties associated with contrarianism just mentioned, the potentially profitable recognition of divergences from consensus thinking must be based on reason and analysis. You must do things not just because they're the opposite of what the crowd is doing, but because you know why the crowd is wrong. Only then will you be able to hold firmly to your views and perhaps buy more as your positions take on the appearance of mistakes and as losses accrue rather than gains.