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How To Disregard What Other Investors Are Doing And Why That's Important

Happy New Year!

Today I wanted to share with you a well-written piece from my colleague and fellow contrarian investment advisor, Steve Jon Kaplan.

A lot of people obsess about what other investors are doing or what the mainstream media is promoting at any given time. This is a very dangerous approach to investing as most investors and even most investment advisors underperform the market year after year.

And when it comes to the mainstream media, they are one of the most reliable contrarian indicators there are. If you want to truly buy low and sell high, look to the most unanimous opinion promoted by the media and do the opposite.

Regarding the topic of other investors though, enjoy the following editorial from a recent "True Contrarian" newsletter.

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I often receive email from people who seem obsessed with what other investors are doing with their money, or how much other investors are allegedly making or losing. Almost all of this concern is based on fantasy, since academic analyses have demonstrated that nearly all investors repeatedly lose money in the long run. The reason is not that investors don't follow the news, or are stupid, or don't understand how the financial markets work, although these factors have some minor influence. The primary problem is that most investors, when they own something which is near a multi-year high, don't think about selling it because "it's doing so well." Investors don't consider future scenarios and proactively decide how to handle them. So almost no one will sell near the top in anticipation of a potential decline, or will position their portfolios for rising inflationary expectations if current inflation is very low. Investors react to events; they don't anticipate them. They only react after it is too late to take advantage of any important changes in the financial markets.

Were many investors heavily in the stock market in March 2000 or October 2007? Of course they were, and on paper many of them were doing fine. But, since the future seemed bright, very few sold. Many bought more shares near the top. In October 2002 and March 2009, investors recognized that the stock market was incredibly depressed--but they didn't take advantage of that fact to add to their equity funds. Instead, they did massive amounts of selling very close to the bottom on both occasions. The biggest monthly outflow in history in the U.S. stock market occurred in February 2009, while the biggest-ever monthly inflow into technology funds was February 2000. It's not different this time: there have been enormous fund inflows into stocks in 2013-2014, with the heaviest buying by far occurring as peaks were being approached. Investors could sell and profit wonderfully, but they're buying instead of selling. When they sell in significant quantities the next time, it won't be until they're far behind and have lost hope of breaking even. In fact, it has been shown that investors almost always sell whenever they emotionally perceive that it's highly unlikely that they'll end up with a net gain. This almost always occurs after there has been such a dramatic decline that a powerful rebound has become the most likely scenario statistically--but is perceived as being the least probable outcome by almost everyone.

During the U.S. housing bubble in 2005-2006, I tried to convince many people to sell their homes. I have tried again during the past year, with equally limited success. In 2000 and 2007, almost no one wanted to sell stocks because they would look at their five-year track records and conclude that the next five years would likely be similar. The same is true today, of course. Do you have any friends, colleagues, family, or neighbors who recently told you, "The stock market has been doing really well, and so has the bond market, so I've sold a lot of my stocks and bonds and put money into something else instead." It would be difficult to find almost anyone who would reach such a conclusion today, or who did so 7 or 14 years ago. Those who were less heavily invested in U.S. equities in 2000 or 2007, or who aren't heavily invested in them now, mostly believe that if they had only done so they would be incredibly wealthy, and believe that those who are heavily invested are somehow geniuses. Of course those who actually purchased U.S. equity funds in early 2009 and who sold them in 2014 have done extremely well, but I doubt that you could find one person out of hundreds or even thousands among all the people you actually know who have taken such action on both sides.

It is also extremely rare to find someone who will say, "The part of my portfolio which has performed the best in recent years is unlikely to continue doing so, while the poorest-performing sectors are most likely to soon rebound. So I'm going to rebalance my holdings to increase the underperforming portion while selling the most of whatever has been strongest." As humans, we become irrationally concerned with "winners" and try to increase our connection with them, while shunning "losers" who seem to be on the wrong track. Since the financial markets are cyclical, it almost always makes sense to do the opposite of whatever we psychologically want to do.

Since I began investing in 1981, I have seen all kinds of assets go in and out of favor. Whenever something is extremely popular, I hear people talking about it and wishing that they had bought it when it was cheap, and envying those who own that asset. In reality, of course, the ones they're envying aren't worth worrying about, because they're not going to sell until they're losing money. On the times when I've been fortunate enough to own some of the top-performing assets, especially when they have tripled or better such as in 2009, I have tried to make sure that I don't wait too long before I sell them--but not to be so eager to unload that I do so prematurely. Of course there is no way to balance both of these considerations consistently on all occasions, so some attempts have been more successful than others. I am careful not to concern myself with others who are allegedly making or losing money, because that will rarely help me with reaching the most important conclusions.

One useful question is to ask yourself this: if I had just arrived on planet Earth from Mars or some other place with all of my money in cash and no history of recently making or losing money in the financial markets, what would I do? Would I construct the same portfolio I have now, or would it be different? If it would be different, then I should figure out why I don't currently have such an asset allocation and how it got to be the way it is now. Most of the time, if I could start from scratch, I'd want to own the same assets I own now. Perhaps I would have preferred buying more of them near their lowest points, but of course market timing is almost impossible to achieve in the sense in which most investors perceive it. If you find yourself making decisions about buying or selling based upon how much money you're making or losing on your holdings, then you're almost always going to make inferior choices.

Speaking of market timing, which deserves at least one or two updates of its own, I will often hear comments such as "I don't think you should buy so-and-so, because it will probably go even lower before it rebounds." Whenever I buy or sell anything, I don't concern myself with how much higher or lower it might go. Instead, I focus on investor inflows and outflows, insider buying and selling, traders' commitments, and sentiment which indicate that a given asset is demonstrating simultaneous multi-decade extremes. If there are simultaneous multi-decade extremes of dislike and deviation below fair value, then even if such an asset goes lower in the short run, I know it will go much higher within a few years. If I'm buying something at 15 dollars per share, I don't worry about whether it will go to 12 or 10, but instead how likely it is to reach 30 or 40 within a few years. I know that it could go lower first, and that's why I always accumulate anything gradually. If we don't have record outflows and insider buying, then it may be premature to buy it. When everyone is asking how much lower something will go, while no one is giving even moderate upside targets, that's almost always a good time to accumulate anything.

My best trades have always been those which I was indifferent about making. I had no interest in buying coal mining shares prior to November 2008, and barely paid attention to funds like KOL. I didn't even look at Russian or Brazilian equities seriously until January 2009. Because I couldn't care less about these subsectors, I didn't consider buying them until they were already quite depressed. In the case of KOL, it kept slumping after I began buying it, and quite rapidly. With RSX in January 2009, the bottom had almost been reached, but that was mostly a matter of luck. Today, the same is true with most funds of commodity producers and emerging markets. I'm not surprised to see the recent rebound for RSX from its bottom of 12.50, because the profit margins of Russian companies have expanded dramatically since the same price for RSX was previously touched in early 2009. I know that it's ridiculous for gold and silver mining shares to recently trade at their lowest levels since October 2008 when they had previously been so cheap, and that recent lows are even more illogical than they had been when almost everything was depressed just over six years ago. The media remain fixated on how much lower the price of crude oil could go, or how much lower the price of gold is likely to go and when it will reach one thousand, and how much cheaper natural gas will become. This isn't any different on similar concerns in February 2011 about how much lower U.S. Treasuries would get, or in the first quarter of 2009 regarding how much lower U.S. stock indices could slump. If you knew that the S&P 500 was a good bargain at 850, then it shouldn't have mattered whether it would first go to 750, 650, or 550. This can be seen in the behavior of top corporate insiders and the other most successful investors in the long run. Insiders don't care if something will go even lower after they buy, or if something will go even higher after they sell, as long as they know they're getting a compelling price on both sides. Those who were obsessed with how much lower the S&P 500 would go may have briefly outperformed those who bought the S&P 500 at 850, but eventually they sat and watched as the S&P 500 thereafter tripled. Those who today are focused on how much lower commodity-related and emerging-market assets could retreat are unlikely to benefit from their next strong rallies--and might even end up jumping in just before they complete their next peaks.

FCG would be an example of an asset which has lost more than half its value just since its June 2014 peak, which makes it an even worse performer than most other commodity-related or emerging-market securities. Is natural gas "hopeless"? Many people would say yes, but this is probably one of the best choices since it doesn't have to return to its 2013, 2012, or 2011 highs to become wildly profitable--it merely has to regain its 2014 top and it will have more than doubled. Some people look at assets which have plummeted more than 80%, such as GDXJ, and conclude that they aren't likely to rebound strongly any time soon. In late 2008 and early 2009, I told subscribers to only buy assets which had dropped more than 80%, and ideally to only buy those which were down by 5/6 or more, for this reason: if something has lost 5/6 of its value and it returns to half of its previous peak then it will triple. Fortunately, quite a few of those assets tripled, even if many of them first dropped further and thus provided excellent additional buying opportunities. Emotionally, it's very difficult to imagine that something which has recently been among the biggest losers could end up tripling or even doubling, but statistically the "loser bin" is almost always where you'll find those assets which will increase by 100%, 200%, 300%, or more.

It's somehow emotionally satisfying for some to imagine how wealthy they would have been if they had done this or that, or to pretend that others are somehow making money. In the real world, almost no one comes out ahead in the long run after adjusting for inflation, because too many emotional financial decisions are made along the way. There are many approaches to the financial markets; those which have proven themselves through the centuries are usually contrarian in one way or another. The reason is that the future is always unknown and trying to outguess someone else regarding corporate profit growth or GDP growth is almost impossible. On the other hand, emotional decisions are highly predictable and have followed the same patterns for millennia, with people repeatedly responding to whatever has recently occurred and almost always projecting the recent past into the indefinite future. Contrarian investing is one of the few methods which capitalizes on the fact that the financial markets are made up of humans who have brains which are wired to make emotional rather than rational decisions. In the short run, emotions often win as ridiculous extremes first become more extreme. In the long run, emotional behavior which causes the most illogical asset distortions will almost always lead eventually to the most dramatic regressions toward and beyond the mean. It always emotionally seems different this time and one can always invent reasons why the present is completely different from the past, but of course there's nothing new under the sun.

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If you lost money in the dot com crash or again in the 2008 financial crisis, I urge you to better prepare yourself from the next bear market. With major US stock indexes again setting new all-time highs, it's critically important to consider now how to prepare your portfolio for the times ahead.

Call 1-800-96-4657 today to get a professional second opinion on your current investments. Our contrarian advisors were able to protect and grow our clients' money in 2008 and can help you do the same in the upcoming bear market.

Flourish and prosper,

Craig Brockie - Registered Investment Advisor
Contrarian Advisors - Rational Wealth Management
Phone: 1-800-96-4657 - Email:
Address: 433 North Camden Drive, Sixth Floor, Beverly Hills, CA 90210