Investing in a Contrarian Style
“Put all your eggs into one basket and then watch that basket, do not scatter your shot.”
— Andrew Carnegie
Investing in a contrarian style is more thoughtful than reactive. Consensus opinions are not rejected by us solely for being consensus; rather, we believe a contrarian will look at the supporting evidence for a consensus and make up one’s own mind as to whether that belief is investable or not. That is how we approach value investing in the U.S. equity market.
Today, we believe investors hold three consensus convictions:
- The overall U.S. equity market is at least fairly valued today, if not somewhat overvalued, using traditional measures;
- Profit margins for U.S. corporation are at the high end of their historical range, on average;
- The outlook for U.S. economic growth is tepid, with likely GDP growth to be low-single-digits for the foreseeable future.
And though we approach this list of convictions with our normal high dose of skepticism, we find no evidence to contradict the consensus on these points.
Where we do differ with consensus is on how to invest in this environment. The consensus today believes the appropriate way to approach equity investing is to:
- Broadly diversify;
- Minimize fees;
- Avoid active investing or, more simply, index.
Here we find fault with consensus.
First, in contrast to the hugely popular conviction that a highly diversified portfolio is the prudent investment course, we believe concentration is the rational response to the broad market’s unattractive valuation, high profitability and low-growth expectations. We believe the intelligent, disciplined investor can find a limited number of companies with attractive valuations, improving profitability (from a low base), and better than average growth prospects even in today’s environment.
Second, we think the flight from fees is nonsensical. When an investor pays no fees, they also have no fiduciary on their side, working on their behalf. If an investor believes that broad diversification is the secret sauce to a successful portfolio, perhaps not having someone on their side is appropriate. But in this environment where valuations and margins are stretched while growth is scarce, a diversified portfolio is unlikely to build wealth. To find money making opportunities, an investor will have to expend substantial effort to uncover them – or pay someone a marginal fee to find them.
And finally, we’re doubtful that investors will realize a wealth advantage in owning indexed vehicles versus active. Over the last few years structural differences of active management versus indexing (higher fees, cash holdings, not capitalization weighted, fewer positions) have been a detractor in a market focusing on large capitalization growth stocks. Further, the widespread belief that low fees and diversification are the secrets of investment success has resulted in very high money flows out of one and into the other, something that we believe has at least somewhat skewed investment results. Regardless, it seems to us undeniable that indexing is the “hot dot” in today’s investment scene, with Jack Bogle the preacher before the choir. Inasmuch as the weight of dollars can drive investment performance, as contrarians we suspect that much of the relative performance of indexed funds has less to do with investment intelligence and is more the result of the flow of money. (In essence, the flow into indexed product has set up a massive “weighted trade,” a situation which usually results in poor long term investment returns – see our piece “The Weighted Trade”)
So looking forward, we believe the prudent investor should be moving toward concentrated equity portfolios where the opportunity to build wealth is greater than in a broadly diversified, indexed portfolio. Dollar cost average away from the index, looking to build a concentrated portfolio of stocks or funds that represent specific opportunities or disciplined styles that the investor can monitor and gauge. It is in this way that the prudent investor can build wealth over the coming years and decades, while all the rest will own the market and miss the trees for the forest.
There is no guarantee that any investment strategy will achieve its objectives, generate profits or avoid losses. This material does not constitute any representation as to the suitability or appropriateness of any security, financial product, or instrument. There is no assurance these opinions or forecasts will come to pass.
The material provided herein has been provided by Linde, Hansen & Co., LLC and is for informational purposes only. Linde, Hansen & Co., LLC serves as investment adviser to one or more mutual funds distributed through Northern Lights Distributors, LLC member FINRA/SIPC. Northern Lights Distributors, LLC and Linde, Hansen & Co., LLC are not affiliated entities. 6187-NLD-3/21/2016