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Posted 7/26/2004
Contrarian Chronicles
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The contrarians goal: To make money
The contrarian investor isnt a crank; hes just a skeptic about good and bad news. And he finds going against the crowd is a good way to increase the odds of profit in his favor.
By Bill Fleckenstein
Contrarian: An investor who seeks to make a profit by acting in opposition to majority opinion, prevailing wisdom, etc., as by buying a company's stock when it is out of favor with the majority of investors.What is a contrarian? My definition is a bit broader than conventional ones because it explains why taking the opposite tack from the crowd can be profitable.
To illustrate this, I'd like to share an anecdote from a place far removed from Wall Street -- Halmand, Afghanistan. Then, it's on to the cell phone arena for a look at the negative consequences of crowd psychology.
In "Poppies Flood Afghanistan; Opium Tide May Yet Turn," a story in the July 1 New York Times, writer David Rohde noted that the large number of farmers growing poppies has caused the price to collapse. "The unlikely winners in Halmand," Rohde pointed out, "are farmers who looked like fools this winter. Sardar Muhmmad, a 22-year-old vegetable grower, could barely contain his glee last weekend as he explained why he chose to plant cucumbers, tomatoes, potatoes and okra this winter instead of poppies. 'I was thinking, no other people grow these things . . . so I thought I could make a lot of money.'"
The pros of being contrary
Therein lies the rationale for being a contrarian: By not doing what everyone else is doing, usually you can engineer the risk/reward in your favor. Obviously, this gentleman was not taking any more agricultural risk in growing these vegetables than he would have had everyone else done the same.
But the fact fewer folks were growing vegetables meant that, if Sardar was right, he would make more money. (In this case, his investment risk was normal, but his potential reward was outsized.) Meanwhile, all the poppy growers who were patting themselves on the back about doing what everyone else was doing (sound familiar?) wound up with too much product and a lot less money, as opium prices have dropped 50%.
It's not that people set out to be contrary just so they can always fight the crowd and look silly the majority of the time. It's that being contrary helps to make the risk/reward factors work in your favor.
Excess capacity incapacitates Nokia
Of course, tech bulls weren't exactly doing any such calculations last fall and winter as they answered the "call" of local number portability (LNP) and piled into LNP-related shares. Thus far it's cost them, because the rate of cell phone users switching carriers -- but keeping their old numbers -- has been much less than expected. Result: lower telecom stocks. Nokia's (NOK, news, msgs) shares are down roughly 30% since the beginning of the year.
I remember saying several months ago that LNP had folks lathered up about nothing. (See my Dec. 15 column, "Building a gadget isn't the same as selling one," and more recently, the section titled "Nokia shareholders bare their fangs," from my April 12 column.) I noted that wondrous expectations for LNP had caused manufacturers to make millions of phones. Of course, that caused chipmakers to get lots of orders, leading to tight supply for some chips. That, in turn, caused the double and triple ordering I pretty much described on the back of all the anticipation.
The stink in groupthink
The bottom line: This is frequently how markets work. When you're in the midst of the excitement, remember that the future often doesn't pan out as folks think -- because the anticipation of the excitement generates behavior that often works against your expectations.
Even if LNP had been a big success, it probably wouldn't have worked out for the stocks of phone manufacturers like Motorola (MOT, news, msgs), Nokia, Samsung (SSNLF, news, msgs) and Ericsson (ERICY, news, msgs) because it had largely been discounted already.
Furthermore, given that there's no barrier to entry in the phone business -- something technology generally suffers from -- and these companies built hundreds of millions of phones when LNP wasn't as big a success as they'd planned, they all wound up having problems, some more than others.
It's just another example of how often, being on the side (i.e., a contrarian) that tries to align the risk and reward of a well-discounted event, like LNP, works to your advantage. Over time, if you can control your risk and occasionally get things right, you will make lots of money. It's the big losses that wind up really hurting over the long run.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. At the time of publication, Bill Fleckenstein held these positions on stocks mentioned in this column: None. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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