Why 2016 could be contrarian investors’ paradise at the NSE

Of course, this is only true until the trend flips on you like it did for NSE investors in the recent interest rate hikes that happened in Q4 2011 to Q1 2012 and in Q4 2015.

Both were a result of fiscal tightening triggered by currency fluctuations. Interest rates and share prices are negatively correlated so shares will normally drop whenever interest rates go up.

This brings into focus the contrarian investor who by design is a naysayer of sorts who is often mistaken for a pessimist in the bull market since they traditionally move in the opposite direction to the proverbial herd.

The Safaricom IPO comes to mind here, I remember asking a client, if everyone was buying to sell at a higher price, who would they be selling to? Of course this largely fell on deaf ears as the herd was already in full euphoria mode.

Being a contrarian investor comes with an equally strong will and self-confidence since you are often labelled an idiot for not following the masses and charting your own lonely path when making investment decisions.

Take for example the recent interest rate hike that triggered a surge of interest in T-Bills from the investing public. It would be interesting to see how many new CDS accounts were opened with CBK in those two months.

The problem for investment advisers like myself was that most of the funds being pumped into T-Bills was being sourced from ill-informed divestment from the stock market.

I say ill-informed because these divestments were happening after the market had already tanked as a result of the increase in interest rates hence selloffs were at a loss.

A contrarian investor would have told you that since interest rates on GoK securities are annualised, that is 20 per cent annually translates to about five per cent for the 90-Day T-Bill which also attracts a 15 per cent withholding tax.

It would thus take you about a year to recover the losses depending on the percentage loss.

The securities market will probably have rebounded by around that time so you were better off averaging down on the losses on stocks that are still fundamentally sound.

Value traps should not feature in this scenario since their decline in value is not directly linked to the increase in interest rates.

Contrarian investors had sold on the first whiff of a weakening shilling and had the funds to buy on the cheap just like they are the only ones you see buying during the festive season when there is little or no activity.

In such a situation, the contrarian was moving in the opposite direction, that is buying the cheap stock and ignoring the high interest rates since these were bound to be short-term and, in effect, setting themselves up for huge returns ‘sometimes mistaken for luck’ that they will reap by selling the very same stocks to the herd when interest rates decline and the ‘flight of capital’ reverses.

The contrarian idea is to ‘buy the rumour and sell the news’ on the premise that if it’s news, the opportunity has already been exploited.

When there is a bubble, the contrarian is never shy to call it a bubble and sell before it bursts and neither do contrarians invest in popular investment advice and tips that are the fodder of the herd investor. To them it’s useless hype that is best ignored.

Ignoring euphoria

Contrarian investors will be the unlikely winners in the current market environment since they rely on their own predictions, are not afraid to take a position regardless of how idiotic or unlikely it seems and they are good at ignoring all the euphoria and hype to make sound and well-calculated investment decisions.

As the US Federal Reserve goes into an interest rate increase phase and foreign outflows push the stock market lower, the most likely scenario is for the herd to seek the seemingly easy way out by shunning the stock market while the contrarian will go into a buying frenzy that will only be limited by funds.

When the cycle ends I can assure you that these contrarian investors will be laughing silently all the way to the bank as the herd wonders how they missed out.

Five rules of contrarian investing:

When you read about it in the newspapers or see it in the news, it is already all over. Buy when everyone wants to sell and sell when everyone wants to buy.

No one sees a bubble when their income depends on it. Take tips or advice and research notes doubtfully. What is obvious to you is not obvious to others.

I think some of the quotes by seasoned investors serve as proof that this could well be the ultimate, albeit elusive, recipe for success in the investment realm.

The classic take from Warren Buffett: “We simply attempt to be fearful when others are greedy, and to be greedy only when others are fearful.”

Perhaps the greatest contrarian investor of all time, Sir John Templeton, said: “Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”

The writer is Business Development Manager at NIC Securities.