Beat the Crowd. Kenneth Fisher

big economic lifeline and ending it was the biggest risk to the global economy, journalists would have to be out of their minds to differ. The commenters and bloggers would tear them to bits. It would be career suicide.

      This makes it easier for real contrarians to sort through the media – there are always exceptions, but in general, it is pretty safe to assume that if headlines hype something, it isn’t a contrarian view. It won’t tell you anything you can act on. For that, you’ll have to venture off on your own.

      The First Rule of True Contrarianism

      Here is the fundamental feature of true contrarianism. If you don’t remember anything from the next nine chapters, remember this: If most believe something will happen in markets, the contrarian simply believes something else will.

      This is what the curmudgeons mess up. Note, I didn’t say the opposite happens. Just something different. Markets price in to today’s prices what the crowds commonly conceive. If everyone is bearish because they see bad things, they might be right that they’re bad – but bad might not mean bearish! Because everyone sees the bad things, and they’re splashed all over the TV and Internet, they might be priced in. Those bad things might not matter at all. Or there could be some fundamentally big bad thing they aren’t seeing at all, and things end up worse than they expect!

      This is what happened heading into 2008. Then, everyone said housing, subprime and toxic mortgage-backed securities were trouble. They would cause a recession and make stocks fall. So many said it! So many saw it!

      No one, me included, saw an even bigger, quiet problem: November 2007’s implementation of the mark-to-market accounting rule (Statement of Financial Accounting Standards [FAS] 157, “Fair Value Measurements”), which could wipe a couple trillion dollars off bank balance sheets globally. No one fathomed that because every financial institution would have to mark every illiquid asset on its balance sheet at the going market price, whenever others sold a mortgage-backed security at fire-sale prices, everyone else would take a hit. Every bank in the US would have to take a paper loss on every comparable illiquid security it owned.

      No one fathomed that this could cause pre-existing problems in subprime mortgages to eventually wipe out about

2 trillion from the US banking system in mere months. No one fathomed that the fear over these opaque, illiquid markets could cause markets to deny funding first to Bear Stearns, and then, six months later, to Lehman Brothers, triggering the demise of two of the five biggest investment banks. No one fathomed how the Fed, after lending JPMorgan Chase money to buy Bear, would deny funding to help Barclays buy Lehman, forcing the i-banking giant into bankruptcy. And no one fathomed how this would trigger sheer panic in the markets, making daily –8 % drops seem the norm. Nor that, through it all, the Fed would forget how to function in a crisis, forget to do most of what central banks traditionally did in a crisis (presuming all of that wouldn’t work), forget to boost traditional liquidity by any measure or act as lender of last resort.

      If it were just subprime and housing in 2008, we’d probably have just gotten a big correction. It wasn’t until around midyear, as the vicious circle of fire sales and write-downs picked up in earnest, that the real trauma started.

      I missed it, too, which brings up the second big rule of contrarianism: You’ll be wrong sometimes. Contrarians know it, accept it. But you don’t have to be right all the time to do fine – a 60 % or 70 % success rate keeps you well ahead of most. As I’ve written in past books, if you’re right 70 % of the time in this realm, you become an absolute living legend. (Although it isn’t impossible that all the snarky new bloodsucking ensures no new living legends ever emerge and endure ever again. Of course, a contrarian won’t care about that – won’t care about self-image. Despite what you may have read of me from my many critics, I care little about my image. Neither should you.)

      The All-Seeing Market

      Contrarians know when not to move and where not to go. How? They know markets are mostly efficient. Not fully, perfectly efficient at every moment – otherwise there would be no opportunities! Contrarians realize markets can be quite irrational in the short term. But over time and on average, prices typically reflect all widely known information. If it’s out there, in the public domain, investors have already considered it and traded on it.

      Rules, conventional wisdom and consensus expectations are all widely known. Ditto for ideological beliefs, biases and every “expert” view. Every textbook theory, rulebook and playbook ever published – markets know them inside and out. They know the rules, know the if-thens and know how most folks are likely to react to every news nugget. Markets know what the crowd will do before the people themselves know.

      The same is true for seasonal myths and technical indicators. Dow Theory is perhaps the most extreme example. This indicator, around since the late nineteenth century, says that when the Dow Transports and Industrials hit new highs together, you get a lasting bull trend. If they hit new lows together, look out below. There is also a lot of mumbo-jumbo in between, but I’ll spare you – the extremes are what matter. If Dow Theory were right, no bull market would ever end because the signal would keep on signaling, and stocks would keep on rising! Same in a bear market. But cycles always turn! Markets have priced all those Dow Theory expectations, and they’ll ultimately do something different.

      Different, Not Opposite

      Whatever the rules say and the herd expects, you can bet the markets won’t do. But that doesn’t mean the opposite outcome happens!

      Think back to our clock analogy. If everyone expects the hand to land on 1, the curmudgeon bets close to 7. The real contrarians remember markets are efficient, so they know the clock probably won’t land between about 11 and 3 – it would be too near where most folks expect. The contrarian can effectively rule out four possibilities. But there are still eight hours’ worth of potential outcomes.

      For example, if most expect stocks to rise 10 % in a year, true contrarians bet stocks probably won’t land in the 5 % to 15 % range. But that still leaves a big up year, flat returns or down.

      Understanding how markets discount known information helps you narrow the range of possibilities. It doesn’t tell you what will happen – that’s where curmudgeons get messed up – it just tells you what probably won’t happen and frees you to contemplate what might happen and improve your odds.

      To narrow the field, the contrarian looks for things the herd and curmudgeons ignore – they branch out. Or they look at the same things but see them differently. Both actions let them find the risks and opportunities most others miss.

      The Right Frame of Mind

      Contrarians are patient – they think long-term. Short-term thinking makes you antsy, and that’s when bad decisions happen.

      You see it all the time when folks chase heat, piling into whatever is hottest purely because it is up the most. They might get bored with broad diversification during a rally and try to concentrate in a hot trend – they ditch long-term thinking for short. Think back to 1999 and 2000. Internet stocks flew high. Fiber optics was the Next Big Thing. The Nasdaq soared, and everyone wanted a piece of the new economy. Dot-coms seemed like the ultimate get-rich-quick magic.

      It’s an extremely short-term mindset, but it viraled. Few thought about where they needed to be in 10 or 20 years (of course, we’re there now). Few looked a year ahead and considered whether companies with ultrahigh cash-burn rates and no revenues could still possibly be in business. They just wanted what was hot then, and they wanted as much as they could get. The bear market beginning in March 2000 was a rude awakening.

      Panic-stricken people think short-term, too. Go back to March 2009, those violent final throes of that financial panic. People truly believed stocks could go to zero. Don’t believe me? Do a Google search on “Can the stock market go to zero?” They asked it. Markets were tanking; zeroness felt real.

      You’re probably sitting there thinking, “That’s not rational.” But panic never is! Folks take those big losses and extrapolate them forward. They lose their grasp of history and reality. They forget the simple truths: Cycles