Issue 56, Fall/Winter 2001

There has been a steadily growing interest in Contrary Opinion theory over the past few years. Beginning in the 1940s, Humphrey B. Neill, who died in the mid 1970s at his homestead in Saxton’s River, Vermont, wrote about Contrary Opinion in his now retired Neill Letter of  Contrary Opinion. I joined him in furthering the essence of the theory in 1962 with The Contrary Investor, a newsletter on investment implications of Contrary Opinion that I continue to write today. Moreover, I began to reprint old books that deal with human behavior and the stock market while slowly moving into money management utilizing a Contrarian strategy.

Today, Contrary Opinion is accepted as an investment tool and, in fact, has become part of conventional wisdom. Whereas for years the uses of Contrary Opinion were always in the back room, now the mainstream has recognized that to make money you buy the downtrodden, the misunderstood and the overlooked. Also, there are numerous investment letters, books, and practicing managers who seek lesser recognized or secondary growth stocks which do have growth characteristics but not growth multiples. New investment books have contrary or contrarian in their titles and institutions, now responsible for perhaps 85% of stock market trading, nod sagely at committee meetings when a manager says he uses Contrary Opinion.

However, reality is not that pure. Many people use the words but not the strategy. Long-term Contrarian investors, which means value players, include Warren Buffet, John Templeton, John Neff, Dean LeBaron, Phil Carret, Irving Kahn, and David Dreman. They all manage significant sums of money and have done so for a number of years. Of course there are others, but at least this gives you an idea of what I mean.

Phil Carret said years ago in his book, The Art of Speculation, published in 1930 (he is still alive today managing money in New York at the age of 89) that the road to success in speculation is the study of values. “The successful speculator must purchase or hold securities which are selling for less than their real value, avoid or sell securities which are selling for more than their real value. The successful investor must pursue exactly the same policy.” Of course, the time requisite for prices to move up is more important to a speculator than an investor. “A security may be undervalued, but if it is also out of style it is of little interest to the speculator.” So, one has to study the psychology of the stock market as well as the elements of real value. When real value is out of favor, a Contrarian moves in. A Contrarian investor waits patiently. A Contrarian speculator, on the other hand, tries to judge the psychological climate with other tools, as charts and technical indicators that will allow him not to wait too long. Let me give you an example. The chart below from M. C. Horsey & Company shows Sears, Roebuck, a major American corporation. Just before the August 1982 rise began, Sears was our company’s largest holding. How did we get that way? Sears was a nifty-fifty stock back in 1972 and early 1973 and then declined with the bear market of 1973-74. It recovered in 1975 and early 1976 and then sank into its own tedious bear market.

During this time, the news was largely negative in that merchandising was not doing well, other firms were taking market share away from Sears and as each year went by the financial press reported more and more negative news. The price kept coming down until finally negative news no longer pushed it down. The stock began the bottoming process in 1980 and, as long-term investors, we began buying in late 1980 right up to late May in 1982. We felt we had value which was then not being recognized.

As long-term investors, we bought too soon but that was not very material once the stock moved up strongly in 1982 and 1983. However, a speculator would have timed the movement better and perhaps bought after a breakout above 21 in 1982. The main Contrarian point is that once negative news no longer pushed the price down to new lows, the price fairly represented all possible disappointments. Of course the chart looked terrible at that time as past history for ten years was downhill, but the unexpected income of positive change, which takes a long time in a corporation as large as Sears, was about to be the next major factor which coincided with a market move that began in August 1982.

Take another example of a recent out of favor company with the chart of Halliburton below. Everybody is aware of the great move that took place in energy related securities during the 1970s that, in most cases, peaked out in late 1980. We then had a sharp fall back, a rise that participated with a 1982-83 bull market, then a continuing down turn based on negative fundamentals for major industries within the energy area. Oil field services represent a volatile sector.

Finally a Contrarian is attracted to the stock price after seeing it decline significantly from a high level, keeping in mind that the high price represents an extremely optimistic scenario and one that would not last. The question becomes where is value and in relation to what level of oil prices. An investor might begin buying in the low 20s and certainly participates below 20. A speculator or trader would wait for more price confirmation, that is of the price stabilizing where bad news is no longer a factor and where perhaps the next level of news is likely to be favorable.

PREDICTIONS AND FORECASTING

Fred C. Kelly, a writer for the Saturday Evening Post back in the 1930s first published Why You Win or Lose in 1930 with a for ward, interestingly enough, by John B. Watson, the founder of behavioral psychology at Harvard. This book is a favorite reprint of ours and in my preface I say we have difficulty struggling against crowd behavior patterns. We don’t compel thinking and observation. We don’t work at contesting the popular view. We are mislead by financial propaganda that makes us untimely in our opinions and often wrong in our actions.

Kelly understands that human gullibility’s are a constant contributory force to speculation. The only change between Kelly’s days and our own time is that crowd reactions occur faster, thus opinions shift quicker, and jumping to conclusions becomes an unprofitable pastime.

Every natural human impulse seems to be a foe to success in the market. We all want to conform, to congregate as a herd. And yet we win by understanding human psychology and by thinking ahead in creating possible courses of action to today’s conformity. You don’t have to be a highly competitive mental person to succeed, you only have to watch and study the crowd in order to pick up useful clues as to what the intelligent minority is not doing.

To succeed in the market one must not do what most others are doing. He who does the opposite has a good chance to be right. We may not know what insiders are doing until after they have done it, but by watching and studying the investing crowd we pick up clues as to what they are not doing. I do not mean that you want to avoid a major current when it is strongly flowing because the uses of Contrary Opinion are most valuable at turning points. To get aboard a major move at the right time, it is only necessary to disagree with the opinion of most investors you know who follow logical reasoning processes fostered upon us by print and TV financial media.

It is not the stock market which beats us. It is our own unreasoning instincts and inborn tendencies which we do not master and which, when we give in to them, lead to disaster. Natural instincts govern action which means that fear and greed are at the opposite end of the investment spectrum. I know, we all think, times have changed, which they have, but human nature has not changed and that is the point of wisdom regarding Contrarian investing strategies.

Another way to look at this is to say that money may be managed profitably or conventionally but not both. Of course, stock prices represent consensus expectations. But to profit, the expectations have to be both correct and different from what is current conventional wisdom. A significant human problem is to withstand group forces that seek to modify and distort individual judgments.

The business of investing is an actual study of social influence. Personal investing is so widespread that a social group has been formed, and we, as individual investors, are no longer indifferent to this group. When we visit brokers’ offices we are alert to the group. If we hang around long enough, we tend to reach an agreement with the prevailing opinion since this is the dynamic requirement of a group situation. Otherwise, our personalities would suffer. Even watching business news on television puts us in the position to accept prevailing opinion. The antisocial solution is to turn off the set.

TREND IS NOT DESTINY – CHARACTER IS DESTINY

We tend to modify our judgment in response to the pressure of majority and expert opinion. Most financial media reinforces majority beliefs and convictions. Investment practices are adopted on the basis of reasons that appear valid. But each investor comes under the sway of an already existing system of practices and values so he cannot judge independently, and he is affected the most when he is least able to exercise his own judgment. In other words, character and temperament are more important than charts and systems. We want to endow investing with specific guides that can be counted on. This is good. But we should realize that our emotions and unconscious behavior patterns, as the tides of the Bay of Fundy, often overrun these guides and just as often leave them stranded.

Independence and basic confidence in your ability to control doubts is a primary requisite for successful investing. Take the case of Xerox as represented in the chart below. Obviously, when Xerox was above 150 in 1972 and 1973, there was little independent thinking  regarding the idea that the stock deserved such a high price. This was group behavior in all its splendor. Then came the market drop of 1973-74 with a bit of a recovery thereafter, but not much when you consider the market bottom in recent times was year 1974 at 570 on the Dow, and the market has moved higher since then. What happened is that the majority belief and conviction that Xerox was a special company, deserving of high multiples and all good things, was dashed through the rest of the 1970s and into the 1980s. To be sure, the higher you were in 1973, the easier it was to fall down and hurt yourself.

Anyway, right through 1982 and into 1984 the majority belief become one of Japanese competition winning the day with copiers, first at the cheap end of the line and then finally across the board. Xerox management was perceived to be incompetent and not paying attention to what was going on. We bought the stock in 1982 and again in 1984 an the basis that management, though a bit thick, was slowly responding to the global changes influencing its business. These changes take time. Finally, by 1984, negative articles no longer influenced the price of the stock. That was the safe time to buy in what technicians might call a saucer bottom. The stock then became our largest holding.

Interestingly, as you might suspect, as the stock rose up, we finally began to see a few nice words about Xerox. News follows the price. As the price moves higher the financial media speaks sweetly.

PRIDE OF OPINION PRECEDES A FALL

I have been saying that a practicing Contrarian observes the psychological status of the crowd in question and then takes an opposite approach. Of course, there are more than one opposite approaches. Normally, if the crowd has decided upon a conventional future, then the successful opposite approach is either more positive or more negative, at the extremes, until one of the extremes becomes the conventional view and then the Contrarian again must take a different road from the conventional view. The theory is based upon estimating the prevailing crowd emotion and not on forecasting the future. We make no attempt to predict the future, and we keep an open mind. Any definite forecast of the future leaves one at the mercy of that forecast because pride of opinion will tend to tie us down to that forecast.

Take a look at a medium-sized stock chart, which is Ransburg below. This company is not followed by Wall Street very closely, is located in Indianapolis, Indiana which people may come from but rarely go to, and reflects future forecasting in price moves. Not of the company itself but of fields of activity that the company represents. Basically, Ransburg is a leader in industrial equipment and is associated with robots. Not surprisingly, the all time high price of above 37 was made in April 1981 when Time magazine had on its cover robots and the tremendous future they represented. This cover journalism forecast of the future left investors at the mercy of brokers who were pushing robotic stocks. Anybody who read Time wanted such items and Ransburg, normally a quiet stock, topped out at the peak of enthusiasm for robots. Obviously, this enthusiasm was not limited to the month of April but had been building up since the second half of 1980.

Again, the high technology boom in 1983, which maximized in June of that year, also saw Ransburg peak out on the basis of high technology and robots. The price came down again only to rise a bit in 1986 on the basis of industrial expansion and the improving of American productivity. Now the stock is back down once more to below the 15 area and is a Contrary Opinion buy since we can choose it with an open mind that is not influenced by delightful future forecasts. These forecasts will come to life but not when anticipated and so far we have had three false moves which undoubtedly will keep investors away until they miss the real move that takes place one of these days.

Oh, I realize that it is easy to make points from charts that back me up. And yet, investing is not a science, and one must enjoy it to do it well. However, we should stick to what we understand, have some guts, and never become too overconfident. Again, Phil Carret once said something to the effect that an investor who so lacks confidence in his own judgment that he won’t buy any security until it is favored by the consensus of the investment community, will buy few bargains and is unlikely to achieve superior results. Of course, a security favored among professional investors is good but that is not the same as being undervalued in price. If unpopular, or generally unrecognized, some investigation is required to estimate basic value. That is where security analysis comes in. Once assured the basic value is there, then unpopularity will not deter the investor who is looking for long-term results.

A good trader, speculator or market technician is trying to do the same thing though using somewhat different tools that offer insights into value. We are all trying to buy things where the future is not already discounted. We want stocks with merit and we should buy them when they are weak. But usually we buy stocks with merit when they are strong and thereby do not build good performance over time.

PATIENCE IS SUSTAINED COURAGE

Another way to look at this is at perspective and patience of the essential requirements. We all want to own shares of successful companies in areas of activity that have particularly promising future prospects. However, the Contrary lesson is that we all tend to be influenced by whatever feelings are sweeping over the investment community at the moment and that true investing, to be successful, requires fighting these feelings. Nevertheless, it is not that simple for the inexperienced investor to be contrary since inexperience breeds a certain contempt for long-term solutions.

Subscribers to advisory services aim at quick results, feeling that the game is not worth the candle unless a system or technique works immediately. An individual, fortunate enough to have an intuitive sense of values, should be able to achieve reasonable profits with some degree of consistency. The key words here are reasonable and consistency – words not in the vocabulary of those who do not yet have market experience.

R.W. McNeel, Financial Editor of the Boston Herald from 1912-1922 wrote Beating the Stock Market, published in 1921 on the human side of speculation – which means attitudes, beliefs, hopes, and fears – the emotions and characteristics that any of us associate with human beings. Now studying people may not seem rewarding. But if you subscribe to the thesis that confidence makes business you study people. Writers tend to emphasize their statistical figures, but people give these figures meaning.

My point is that character is as essential as knowledge, even more so today when basic statistical knowledge is readily available. In McNeel’s day balance sheet figures were less reliable and yet they were relied upon. In our day statistical analysis is clearly stated and asset values are known yet the same stock swings take place. The constant element is the human side of finance – that has not changed. Natural instincts will unquestionably govern action.

To illustrate, fear is probably the oldest human instinct. It is universal and deep rooted. It is the outgrowth of self-preservation whereby we have been able to survive over time. To quote McNeel: “Because of its ancient origin and its great strength, man is at times exposed to the absolute breaking down of his courage under certain conditions and frequently without cause.”

The other side of fear is greed or from the instinct point of view that of companionship or gregariousness. Investors tend to flock together. We have an inborn tendency to do what we see someone else doing. Investors become excited and tend to act like lemmings as they enter into the active or emotional states of others.

Consider how basic instincts cause us to act in the stock market. We are told to buy low and sell high. Yet stocks are never low unless the headlines are such as to cause the great majority of active investors to sell. Selling is usually a creation of financial necessity, needing money, or more largely through fear of pending developments in the world that make you feel that prospect of financial 1055 is certain. Stock market bottoms are created when we sell stocks at ridiculously low prices without conscious reason. Whatever that price level is at, it will look low in retrospect. Recent examples are Dow 570 in 1974, 770 in 1982, and 1079 in 1984. This may be a pattern of rising bottoms, but each one offered exceptional opportunities for the purchase of stocks. The opportunity is only there because most of us are unable to turn our instincts or emotions upside down and buy while others sell.

McNeel said: “In order to avoid selling, and on the other hand to buy, he must put his natural inclinations to the test of reason and determine whether they are sound or unsound.” Every investor tries to do this, and I find from my own personal experience that it is easier to do this if you are physically divorced from the financial black holes of enthusiasm or despair which means the major metropolitan centers. I am in Burlington, Vermont because it is just enough off the beaten path to make it a Contrarian’s delight. Hopefully, this keeps us a bit away from the inborn tendency to act in common with others.

A few axioms to the uncertain art of economic prophesy follow; I will create a baker’s dozen guidelines:

1. The system is there is none. I know this sounds strange but successful techniques are counterproductive when widely followed. Systems that work usually come to your dinner table as food for the future when actually they are the result of previous activity that is now so popular the system is not worth buying. What one needs are systems at the breakfast table, for sustenance over the coming day. Usually, one receives a system too late.
2. Consensus hopes or fears are embodied in current valuation levels. The corollaries to this are that realization of expectations results in no price change while realization of unexpected outcomes moves prices. The chart of Aetna illustrates this point of view which is represented by “The Trader” column by Floyd Norris in the 18 June 1984 issue of Barron’s [see Exhibit No. 1]. Norris had attended the seminar on Value Investing sponsored by the New York Society of Security Analysts where I was a speaker. His attention was drawn to my mention that property/casualty insurance companies appear cheap in the marketplace. The letter to the Editor is from the 25 June issue of Barron’s and concerns our mentioning of bottom fishing for property/casualty insurance companies [Exhibit No. 1]. The point of Mr. Swift’s comments is that the entire industry is so bad off that our timing is nowhere near correct and investors should continue to avoid the entire area.
   Of course, Mr. Swift’s letter represents good thinking and its inclusion in Barron’s reflects a certain style of consensus wisdom. The question comes down to that once your worst investment fears are realized, there is only upside potential left. But what are the worst fears? Is there a real crisis in the property/casualty insurance group or is it a case of the negative atmosphere being so strong that this is not the time for selling but rather the time for buying? Needless to say, the stock prices of both Aetna and Continental were both within 30 days of lows that have not been seen since.
3. The ability to sense what is going on in the economy is more important than organizing facts. The result is that indicators are no substitute for judgment. Besides, a simple yardstick of value can beat exhaustive consideration of all relevant facts. When you have too many facts there is the question of selection. To illustrate, low price-earnings ratio investing is an extremely simple strategy which works over time, probably because of its simplicity.
4. There is a failure to perceive new reality. In other words, it is difficult to see the significance of outside events which produce new watersheds. A recent example is the climb of energy prices into 1980 and their subsequent decline into 1986. Most of us act like generals who are fighting the last battle in a new arena where we carry our experiences forward without taking into consideration the changing environment. The future is not always a continuation of the past. Be skeptical of past trends being stretched far beyond the present. The elastic may break or snap back when least expected.
5. There is a cultural-psychological lag in experience over expectations. We all have a tremendous capacity to believe anything until it is no longer worth believing. The human factor tells us that we see things according to our preconceptions, which then paralyze perceptions. Indeed, when the market operates correctly, each investor reports a slightly different version of what is going on in the market and what signals he feels the market is sending us.
6. Trend is not destiny. The future is never clear, and one pays a high price for a cheery consensus. The result is that uncertainty is a friend of the long-term buyer, and we need to take a position when most lonely. Easy to say, but not easy to do. Be suspicious of widely held views. Educate yourself for ambiguity instead of certainty, and you have a chance for success.
7. Character is destiny. Do not put your trust in those who are trying to hustle you but rather believe in your own common sense. Remember that our behavior patterns are restless and dynamic, with emotions often making for strange statistical measurements. For a Contrarian it is better to be right by oneself than be wrong in good company.
8. The bedrock of reality is a world of disequilibrium. Instability is a fundamental characteristic of transition. As Le Bon, the French writer of The Crowd says, a crowd yields to instincts that individuals suppress. Rational outside perspective tends to remove you from current investment climates.
9. The art of forecasting is in the choosing. One has to decide what is important and what is not. We need time to reach conclusions. We react to each new piece of information as concrete evidence of a new trend that supports some exciting premise. The rise of gold and silver in 1980 was a wonderful popular delusion. The Hunt family of Texas was then worth over $5 billion and now, after some years of adversity, the family fortune seems to be well under $1 billion. Still, a nice piece of change but not exactly what they were used to in 1980.
10. The future is both promising and threatening. This is always the case whether or not perceived to be. So, how you look at the future is largely dependent upon your own psychological makeup. Every human is anxious. We want to hear answers we agree with.
11. It is better to know some of the questions than all of the answers. That is because the answers don’t work out. To be sure, things are more like they are today than they ever were, but most of us worry over answers to an extent that worry consumes the spirit of action.
12. Complacency breeds surprises while fear breeds opportunity. We have a few dozen buttons with sayings on them, some of which are part of this article in various sentences. In this regard, patience is sustained courage, and without curiosity, conviction is stubbornness.
13. Take not thyself too seriously. Take your work seriously but don’t confuse brains with a bull market.
    This is a good place to say that it is of major importance in using the Theory of Contrary Opinion to be contrary to words and opinions, not to facts. It is words that mislead, distort, and delude. To paraphrase Gustave LeBon, one of the great writers on the crowd mind, we see how words are used as a mechanism of persuasion. The four requisites are:

• Affirmation – affirm the word as truth
• Repetition – repeat over and over
• Contagion – finally it catches
• Prestige – and imitation results

Contrary thinking cannot advise you – it can only suggest Contrary trends. We are creatures of habit and prone to recession or prosperity mentality. The irony is that widely followed forecasts bring about their own demise.

Furthermore, one does not get by in being contrary alone, one must also be curious. Nobody can afford to jump to conclusions since we have to look at the whole picture. The Contrarian can clarify thought so that recommendations fall into place. But don’t force them. Think first. Don’t expect the market to conform to your own preconceived opinions. It won’t. Flexibility plus thought plus work equals a chance for success. Rigidity of mind does rot.

OBJECT, PURPOSE, METHOD, PREMISE

Let us review a bit and put more pieces together. The object of contrary thinking is to challenge generally accepted viewpoints on the prevailing trends in politics, socio-economics, business, and the stock market. Opinions react sharply as people’s emotions – their hopes, fears, and passions – sway back and forth.

The contrarian’s purpose is to contest the Popular View because the view is usually untimely, misled by propaganda, or plain wrong.

The method is to compel thinking and observation in place of conclusion hopping and snap-guessing. “Think prodding” or the necessary concentrated reflection takes practice.

The premise is that alternative ideas make for a clearer, betterdefined judgment. Taking a contrary position frequently will suggest what is NOT coming next. When thinking through opposites, one is led to sound thoughts as to what might come next.

Is the public always wrong? Is the Crowd never correct? After all, we live in the most enlightened democracy of contemporary times, and individuals – acting in mass – pull the voting levers.

For a correct answer we must rephrase the question. Is the public wrong all the time? No. The public is probably right more of the time than not. But the public is right only during the trends and wrong at both ends – usually wrong when it pays to be contrary. (I feel we may include institutions as acting public-like in their investment activities. The market sheep are not all individuals. The fatter flocks just trample more ground.)

Professor H. F. Harding of Ohio State once wrote me that “the odds are always good that the exceptional man is well ahead of the crowd. When they catch up he is off in another direction.” The modern problem is that the speed of change influences the process and tends to compress all movements. Remember Voltaire who said: “It is only charlatans who are certain. Doubt is not a very agreeable state, but certainty is a ridiculous one.”

Contrary Opinion theory is being discussed more and more in the financial media as both professional managers and amateur individuals tend to use the expression when it fits them. Accordingly, everybody is becoming aware that to do the opposite of what most people are doing is the way to win. Simply, you win by being contrary.

Most of us should act as true investors. Forgetting about market liquidity and the speedier ticker tape, while relying on our judgments of what an investment will bring us over longer periods of time than a trading cycle.

There are different approaches to the problem. The specific investment need of many Contrary Opinion readers is to tailor a program around undervaluation. This means you establish that securities purchased are worth more than they are selling. Characteristics and criteria are set up. The following fundamental guidelines serve as a beginning:

1. Past records give a point of departure for analysis. Average earnings, dividends, asset values and their trends should be examined. Tangible value is the secret, either in a turnaround situation or a special asset stock.
2. New and relevant facts that expect to have an influence may be present. These facts should not yet be fully realized and appreciated by a majority of the financial community. (Clearly, technical analysis offers portraits of sentiment which aid the decision making process.)
3. A lower speculative component is essential. The measurement and delimitation of securities into investment and speculative areas is desirable. The method is largely to ignore popular trends and to buy ex-public participation.
4. After basic principles, the distinction is still one of personal imagination and ingenuity. Confidence in market level factors influence price-earnings multiples. But a strict ladder analysis, where you try to escalate your stock over comparative choices, is not good practice.
5. Try to purchase under favorable conditions. A clear-cut demonstration of superior attractiveness is still subjective judgment. Facts and ideas favorable to purchase are remembered, while negative factors are forgotten.

Do not adhere to any formula or system. Keep no idols, but rather stoke your noggin with antidotes for the temptation of conformity. Rely not on a consensus indicator approach as a substitute for common sense. Then you will not be short-circuited. In fact, you may even win.