'Tis the Season to Be a Contrarian Investor - But Is it Worth it?

Contrarian investors may have done really well when the tech bubble burst, but similar strategies haven’t fared very well since 1997 and 2008 was another poor year for their track records.

They likely called the top in global trade growth but probably gave back the gains attempting to predict the bottom in financials. Meanwhile, contrarian asset allocators should have done far better, since they would have been bearish on risk assets a year ago.

Regardless, it is particularly tempting to make big price reversal calls at this time of year, according to Robert Buckland, chief global strategist at Citigroup. “It’s so much more gratifying than backing momentum strategies,” he told clients.

There is a tradition of brokers taking their clients out for a holiday lunch at this time of year. After a little to much food and drink, the event often turns into a stock-picking competition – with the top performance winning a prize at next year’s lunch.

“These lunches usually descend into an orgy of contrarianism,” Mr. Buckland explains, with few resisting the temptation to make a contrarian pick – the collapse of a high-flier or a positive move for a dog. And this vanity infects us all, the strategist said, since bragging rights are so much greater if you call the top or bottom.

Contrarians appear to be better at macro calls such as sector, regional and asset allocation moves, Mr. Buckland said. Right now, contrarian asset allocators are likely buying equities and selling government bonds. Meanwhile, contrarian stock pickers should be buying financials and selling pharmaceuticals and biotechnology.

As a result of low equity valuations, Citigroup is more willing to back the contrarian asset call than the contrarian stock call right now. “Contrarian stock pickers probably need a turn in the global profits cycle, which we do not expect until 2010,” Mr. Buckland said.

His market-neutral contrarian buys the worst and sells the best ten performers from the previous year, with a universe of the 250 largest global stocks. This approach has produced a positive return in only four of 11 years, while the return was only meaningful in 2000. In fact, if C$100 was invested in this strategy in 1997, an investor would have just C$33 remaining.

For example, a contrarian bull would have bought Royal Bank of Scotland (RBS) this year as it lost more than a third of its value in 2007. However, it has fallen more than 85% in 2008. Likewise for Fannie Mae (FNM), which fell 41% in 2007 and more than 95% this year. Home Depot Inc. (HD) has lost 33% and roughly 8% in the past two years, respectively.

On the bear side, however, the performance of the ten stocks likely shorted by contrarians have fallen 47% compared to a 43% decline for the global market, Mr. Buckland noted, adding that this and more has been given back on the bull picks. He said the message for next year might be to avoid chasing the themes set in January 2009. “We have never really understood why people expect so much to change at the start of a new year,” the strategist said.