Motley Fool: Betting on the contrary doesn’t always pay off

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When I first became interested in investing in the 1990s, the fashion was to be in with the in-crowd.

Everyone wanted a slice of the new economy, and discussion among members of The Motley Fool’s community – and even its writers – often amounted to whether ‘this dotcom favourite’ would go up 50 per cent in six months when ‘that one’ might manage only 20 per cent.

Such universal optimism. It truly was a different world.

Two stock market crashes in a decade have since scared many people off picking shares altogether. Indeed, more and more people don’t trust the professionals to do a better job, either, as we’re seeing with the rise of increasingly popular index funds at the expense of active fund managers.

A minor mania

You’ll now often hear those who do still love to pick their own stocks proclaim that we’re contrarian investors who go against the crowd – as opposed to those punters who chased technology shares to unsustainable heights in the 90s.

I certainly count myself as an independent-minded value-focused investor, and it doesn’t feel like such a lonely label these days.

Indeed, the only real flush for hot stocks that I can remember among UK investors in recent years was with the mining and oil share boom of the last decade.

The mining bonanza cratered a few years ago, however, and such shares have sunk the portfolios of those who held on to them. The same thing has happened more recently to oil companies, too. The oil price crashed in late 2014, and the shares of related companies have plummeted in the aftermath.

With them died the dreams another generation of overly optimistic private investors.

Sidestepping a super slipup

Of course, if you’re a real contrarian investor – as opposed to somebody who just doesn’t want to look like the investing equivalent of a groovy granddad wearing flares and corduroy jacket to a rave – then these savage booms to busts are music to your ears. Truly contrarian-minded investors would have avoided being caught up in the hysteria about the commodity super-cycle a few years ago
that sent prices into the stratosphere.

And equally, you’ve got to suspect that the sector is so hated by the masses now that there may be some bargains on offer.Needless to say, it never feels comfortable to buy at the point of maximum pessimism towards any particular corner of the market. But if you can get your time right – a big “if”, with triple underlining and flashing lights for good measure – then there are fortunes to be made.

Most people will never do this. By definition, most people cannot be contrarian investors.

Therein lies the opportunity – and risk – for those of us who try.

Here’s one contrarians did earlier

Consider the homebuilding sector. In the wake of the financial crisis, many builders were straddled with huge debts even as house prices began to melt and demand evaporated along with confidence and access to mortgages.

To give just one example, at the low point of 2009 the market capitalisation of erstwhile sector giant Taylor Wimpey down below £100m.

Many people wrote the firm off for dead. But with hindsight, this pessimism was overdone.

Today Taylor Wimpey is valued at £5.6bn – more than 65 times greater than in the depths of the slump!

Of course, you were unlikely to have bought at the very bottom, even if you were a true contrarian. In the real world it would have been just as likely you invested too soon and saw your shares plunge in value, at least temporarily.

But Taylor Wimpey’s share price is still up very nearly 600 per cent even in just the past five years – so well after sentiment began to turn – as the sector has been rehabilitated by a return to growth and a return to optimism among investors.

Getting in on the second floor

Timing is clearly critical when betting on a return to good graces with these cyclical areas of the market.One way to hedge your bets may be to wait for a resumption of stronger trading across the sector concerned.

Sure, there’s no chance you’ll get shares at their cheapest like this – the market will virtually always sniff out a recovery long before it shows up in stronger reported profits.

But as the homebuilders’ years of subsequent strength have shown, you don’t need to pick the bottom to end up on top.

Being contrarian doesn’t mean avoiding stronger share prices, anyway. If it did then you’d always sell up after just a few percentage points of gains – and almost certainly badly lag the market, as you’d continually trade away your winners. Rather, the aim is to get into a sector after it’s turned but before the masses arrive. And to keep one eye on the exit!

Three beaten-up sectors worth contrarily considering

So where might contrarian investors go hunting now?

If I knew with any certainty I’d be a billionaire, but some embattled sectors do look attractive to me. The banking sector, for instance, is one where we’re seeing a recovery in profits but still some difficulties such as fines and higher costs, which have kept the lid of share price gains. At the same time many investors are still shunning these companies entirely, which may mean they’re still priced too pessimistically.

Elsewhere, I think it’s very likely that commodity companies such as the big miners, the integrated oil companies, and the host of smaller companies that provide equipment and services to the sector will spectacularly outperform the wider market sooner or later.

Unfortunately, I don’t know when. But the conditions are ripe in terms of despair and hatred towards the sector, in my opinion. However, earnings are still being remorselessly ratcheted downwards. Given what I said about timing, it might be best to sit on your hands for now and to wait for the first signs of a recovery in profits, before you look to profit in your own portfolio.

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