In general, it does not pay to be a contrarian. The trusted saying that "the trend is your friend' is alive and kicking. So by default, you cannot be a contrarian and expect to make money in this game.
Contrarian strategies however are good when things go to extremes. That is, when everyone is a super bull or a super bear. Only at those tipping points does it truly pay to be a contrarian, for in all other cases, you go against the trend and that is a no-no.
So let's see some extreme charts
Yesterday I saw a chart that amazed me:
If this sentiment survey is correct, the Bull/Bear ratio is at the highest point ever over the past 15 years or so.
I checked around to see other sentiment surveys, and more or less all surveys are way up there close to record bull territory. So when everyone is ultra bull, who is left? Put it another way, when everyone already has stocks and is hoping for them to go up, who is left to buy?
So can the S&P 500 (NYSEARCA:SPY), NASDAQ (NASDAQ:QQQ) and the Dow (NYSEARCA:DIA) continue much higher without first correcting? Is it possible that everyone is correct? It is possible, but unlikely, for we know from experience that when everyone is super bullish, that's where markets correct, for reasons that escape us at the moment, but nevertheless show themselves in the future.
The next eye-opening chart comes from Yardeni.
Now this chart can be interpreted in many ways. For example, it's a good thing that after tax profits from production are so high, because it means people and companies are making money. But it also means something else. It means, this is probably as good as it gets.
Granted that if profits stay at elevated levels for a long period of time, this market deserves to climb to much higher levels, however, from a contrarian point of view, this is where you want to go against the crowd if you feel things can't get any better. Even if that means you feel the market might correct for no reason before going higher.
This might be a good shorting environment
2013 was probably one of the worst years on record to short stocks. It did not matter how ludicrously expensive a stock was and if it made money or not, if it was in the news, chances are that it went up.
So this year it might be worth trying shorting some of the high flying super bubble stocks of last year, like LinkedIn (NYSE:LNKD), Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR). I am not sure how long this social bubble will last, but if one looks back to history, he will observe that bubbles always pop at some point.
I have written about all three stocks in the past and all that I have said still stands -- mainly that the stock price in all three cases is so far ahead of the fundamentals that even the slightest deviation from market expectations can bring these stocks down like a rock, irrespective if they continue to do relatively good for many years into the future.
I am not particularly bearish, but the chances of the market going up by 30% two years is not a bet that I would make. And while I do not recommend going against the trend, if the charts show weakness, being a contrarian in an extreme bullish environment will probably pay off.
Whether you choose to be a contrarian or not is up to you, but one cannot help but notice that the last time U.S. markets opened on a negative note was in 2008, and that was a very bad year.