Tuesday, November 22, 2005

Kevin Armstrong: Fashion is to oppose consensus

The challenging of views is essential for investors. No one is right all the time and continually challenging the robustness of one's own conclusions is vital; success in investing is always a moving target.

Taking a contrarian view to a broad consensus has become a far more popular approach to investing over the last five years, with the result that most investors now have a keen eye out for a consensus view to bet against. The problem is true consensus is rare and identifying it is hard.

In the late 1990s, contrarians were hard to find; they generally didn't survive long. There was a broad consensus that the world was in the early stages of the next industrial revolution, a technological revolution spearheaded by the internet.

Productivity was set to escalate, the business cycle was dead and valuation no longer mattered; share markets could soar to previously undreamed of heights.

For a while Federal Reserve Board Chairman Alan Greenspan was a contrarian. In 1996 he coined his now famous "irrational exuberance" phrase. The problem for would-be contrarians was the consensus they were betting against just kept getting bigger, proving, if proof was needed, the famous line attributed to the great economist John Maynard Keynes: The market can stay irrational longer than you can remain solvent.

This is the danger of attempting to identify a broadly held consensus view: the view, or then prevailing conventional wisdom, can be right for a long time.

The longer it appears right, the stronger the consensus becomes that it is right. When this happens, the ultimate downside, or unwinding of the consensus, is generally far greater.

This is what investors witnessed in early 2000. This was the peak of the largest investment mania the world has probably ever seen and, with hindsight, it seems the peak must have been obvious.

It occurred when just about everyone's expectations and confidence were as high as they ever get. Unfortunately the clarity of hindsight is not available until it's too late, and of no value.

Nonetheless, the experience of the 2000 peak and its aftermath started the slow process of educating investors away from merely extrapolating the current trend ever further into the future.

Two and a half years later, sharemarkets throughout the world were enduring their worst bear conditions for many decades and investor optimism had soured to extreme pessimism. The outlook was grim and deflation and depression were the buzz words.

It seemed the bear market would roll on for years.

Just as hindsight showed that the peak in the market was coincident with the peak in optimism and hope, hindsight also shows the low in the market was coincident with extreme pessimism. As time passed, and wounds healed with rising markets, once again it seemed that the trough must have been obvious at the time.

The re-education of investors took another step forward along the path towards contrarian investing.

It can be argued that one of the greatest of all investors, Warren Buffett, is a contrarian.

While he is usually described as a value investor, his value discipline results in him only buying when others have sold an issue down to a price that he finds attractive, and he was aggressively absent in the internet mania six years ago. He was so absent, in fact, that he was ridiculed for not getting in on the new era.

So there is absolutely nothing wrong with being a contrarian investor. It's just that the really important opportunities only occur at very major extremes and, almost by definition, extremes are rare and everyone can't be a contrarian.

There are not always going to be opportunities to be rewarded for taking a contrarian view and identifying the ultimate turning point is almost impossible.

Warren Buffett's time scale is substantially longer than that of most investors. Not only can he generally exercise the patience to be proven right, he also buys with the intention of holding, not looking for the opportunity to sell at a slightly higher price.

In the space of less than three years, two almost opposite extremes were seen, particularly in America, in sharemarkets.

It is quite possible that no greater selling opportunity than was presented in early 2000, or greater buying opportunity than was available in late 2002 and early 2003, will be seen for many, many years. These were historic extremes from which great contrary strategies could be built.

With all this in mind the question that arises is: can all the speakers at the New York conference really be taking contrary views?

The answer to this is probably no, at least not when compared to the extremes described above. However, many investors now have far shorter time frames, turnover of portfolios has increased and small movements in markets can be seen as opportunities to be exploited.

Some of these shorter-term moves will be quite rewarding and may have been highlighted or supported by shorter-term sentiment measures that attempt to identify the consensus.

These approaches may be useful for hedge fund managers or traders but, for long-term investors, it is probable that looking for a major consensus, at least in the US share market, may be an exercise in frustration for many years to come.

* Kevin Armstrong is chief investment officer for ANZ and The National Bank


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