Genuine contrarians are rare on Wall Street. When “blood is running in the streets,” to quote that famous — and genuine — contrarian Nathan Rothschild, hardly anyone wants to buy.
This is worth remembering now since seemingly everyone on Wall Street has become a latter-day contrarian, claiming to detect the widespread bearishness that justifies a contrarian buy signal. By definition, not everyone can be a contrarian. When a genuine contrarian buy signal is eventually triggered, few will believe it or follow it.
One of the best descriptions of a true contrarian comes from the British economist and philosopher John Maynard Keynes: “For it is in the essence of his behaviour that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”
No wonder there are so few genuine contrarians.
“ Extreme positions are far more often than not exaggerated — and to that extent wrong. ”
The core insight of contrarian analysis is that extreme positions are far more often than not exaggerated — and to that extent wrong. When the news is seemingly all good and bullishness is at extreme, it’s a good bet that investors are ignoring the bad news that also exists. That means stock prices have been bid up to unjustifiable levels, and the path of least resistance is down. The same process, in reverse, works when bearish sentiment is at an extreme.
In the wrong hands, this core insight becomes the excuse for sloppy thinking. If you want to be bullish and claim contrarian analysis supports your position, you can always “find” plenty of bears to be your contrarian foil. At the same time, you can be bearish and still wrap yourself in the contrarian flag, since there will always be at least some bulls you can oppose.
The antidote is to rely on an objective measure of sentiment. Only when it reaches an extreme would your contrarian analysis kick in. There are many different objective sentiment measures, and it’s beyond the scope of this column to analyze their relative merits. The key point I’m making here is to pick one and then follow it.
Regardless, my hunch is that you will not find contrarian support for the belief that the bear market is over. As I reported last week, several objective sentiment measures are each indicating we have not yet seen the “throw in the towel” capitulation that typically accompanies major market bottoms.
That doesn’t mean the market won’t rally. But, by my contrarian analysis of the sentiment indicators, the path the market takes to a new all-time high will take it lower first.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]