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INVEST FOR SUCCESS Time for Contrarian Plays? by Ted Shaker
“Buy low and sell high.” When asked, this will most likely be the sound bite given by professional investors in response to the query of how to achieve investing success. But how is it that something so elegantly simple proves so elusive? The answer is rather complicated but has its roots in human psychology. Although the psychology of investing is way beyond the scope of this article, we must briefly explore polar-opposite emotions that ultimately sabotage investing performance: fear and euphoria.
The following discussion will most likely sound all too familiar. When a particular stock, sector, or market is hot and has recently risen in price significantly, many of the pundits on TV and the written page come out of the woodwork to discuss and hype the story. As the individual investor continues to be bombarded by the accolades of this particular story, the euphoria, or greed if you will, begins to take hold. This is when many of us begin to take a position, after hearing time and again how wonderful this investment has been and will continue to be. But what happens next is the inevitable outcome of mass euphoria. The “smart money” begins to sell their positions to the unsuspecting public thus locking-in their significant profits. This selling puts pressure on the price and begets more selling on the downward momentum. As the price drops, sometimes precipitously, this is when fear and discomfort begins to creep into the equation. Ultimately, the individual sells at or near the lows in an attempt to end the psychological pain and fear of continuing loss. This is the classic case of a hype-driven disaster. But please don’t feel obtuse, as this happens to the best of us, as the recent collapse of several billion dollar hedge funds can attest.
One of the antidotes to such hype-driven euphoria is taking a contrarian approach to your investing activity. In its simplest form, a contrarian approach to investing aims to engage in the opposite activity as that undertaken by the majority. In essence, the prudent contrarian begins to develop positions when everyone else is selling and conversely sells when the euphoria is at a peak. The reason that this works is gleaned from simple supplydemand economics. When the virtues of a stock, sector, commodity, or market are being continually extolled and hyped, the chances are that most of the money available to fuel the ongoing price ascension is all but exhausted. In such a case, the only significant direction of money flow will ultimately be out of the story. This will always leave the late comers holding a loss. Just the opposite is true when a stock, sector, etc. is relatively hated by the public. The only significant change in money flows in this case will inevitably be into the “hated” story.
We currently see opportunity, as contrarian plays, in two sectors: the left-fordead housing sector and technology. Turn on any talk show that is discussing the economy and you are likely to hear of the demise of domestic real estate, which has removed billions of dollars in market cap from the sector. The selling, however, looks to be over, as the worst case scenario is already priced into the sector. Look to the best-of-breed such as Toll Brothers (TOL, $28), Pulte Homes (PHM, $31), and DR Horton (DHI, $23) for the builders. We also like the retail chains Home Depot (HD, $36) and Lowes (LOW, $28) at these depressed prices. Although not strictly levered to home building, take a look at Fortune Brands (FO, $74) for a nice mix of top line products.
Technology still renders visions of the disaster that followed the 2000 peak, with the Nasdaq still well under half its premeltdown highs. Technology, however, continues to provide the engine that drives productivity. A swath of new products and the need for corporate upgrading bodes well for some of the best in the sector. We like Cisco Systems (CSCO, $22) as the dominate player in the high-end router market. Microsoft (MSFT, $27) will almost surely break $32, with its $30 billion stock buyback providing a firm floor for its stock price. We also like the longterm prospects of Corning (GLW, $24) with its leverage to fiber optics as well as big screen TVs. As a speculative play on bandwidth development, take a look at a new IPO that almost assuredly came out under priced (DIVX, $20).
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