The Contrarians Have Got It Wrong
by Tom Dyson
April 27, 2006
Contrarians say to make money all you have to do is trade against the crowd.
The moment a crowd becomes convinced by an idea, you know everyone is already on board so there’s no one left to buy. A move in the opposite direction is therefore the path of least resistance.
Many investors claim to be contrarian. In my experience, very few make it.
The simple truth is it’s really hard to be a contrarian. You risk looking like a fool. And people hate looking like a fool, especially when money is involved. Most investors would rather lose money with the crowd than take an unpopular position. It feels more comfortable. And it gives them an excuse when it goes wrong.
This is especially true in the money management business.
I always try to be a contrarian. Expensive stock market lessons have taught me it’s the best path. Now I won’t make a move any other way... or live any other way. Just ask my wife. Or my boss. They’ll tell you I’m the most contrarian individual you’ve ever met...
Which brings me to bonds.
Over the last couple of weeks I’ve written several columns about government bonds. Today I think a bond investment is one of the surest ways to lose money over the next few years.
Here’s the argument:
There is plenty of sand in the desert and plenty of salt in the sea. There are also plenty of government bonds floating around. The supply of government bonds is limitless. And they never get consumed.
At the same time, government bonds – on the whole - are about as pricey as they’ve ever been.
Check out this chart of government bond yields of five countries...
In my mind bonds are the perfect short sale.
Thing is, I’m not the only one who recognizes this. In fact, it seems everyone on Wall Street thinks the same thing. I heard somewhere that 98 out of 100 economists think interest rates will rise and bond prices will fall. One survey of fund managers put the figure at 100%. Even the retail investors are in agreement.
If everyone thinks bond prices are set to fall (as interest rates rise), then the path of least resistance must be up. Buying bonds – betting on falling interest rates - is the contrarian play.
Not so fast.
This time I think the contrarians are wrong. They have over-complicated this issue and missed the basics. The fact is, bond prices have risen for 25 years, in one of the most durable bull markets ever seen. That’s 25 years of pent up selling power... just waiting to flood the market.
The crowded trade must be on the long side, no matter how you look at it.
Governments manipulate the bond market. This is why sentiment is out of whack with price. Over the last few years, the East Asians soaked up all these bonds to help grow their economies. Now we have a situation where the speculators are all on one side of a trade facing off against the central banks.
I’m reminded of George Soros. He led speculators to attack the British pound in the early 1990s. Back then contrarians would have told you to buy pounds because the whole investment community was bearish on them. The contrarians got killed. The market always beats government intervention in the end.
Bottom line: Don’t be fooled by what the crowd is saying. The crowd isn’t behind the big selling power here. The governments are. If you buy bonds, you’ll find yourself staring down the largest stack of paper money ever accumulated.
A bet on higher interest rates is the true contrarian trade, even if the whole investment community agrees with us. I would buy the Profunds 30-year Rising Rates Opportunity Fund (RRPIX).
Good investing,
Tom
