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At the Money: Contrarian Investing · Masters in Business

• 0:00
  Speaker 1: You don't need to follow me, you don't need to
• 0:04
  Speaker 1: follow anybody. You've got to think yourself.
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  Speaker 2: You're all individual, Yeah.
• 0:14
  Speaker 1: You're all different.
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  Speaker 2: Yeah.
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  Speaker 1: Everybody wants to be a contrariant. We want to be
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  Speaker 1: the person who sells at the top as green, consumes
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  Speaker 1: the crowd, or buys into the lows when the panic
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  Speaker 1: mob loses its mind and causes a crash. It's an
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  Speaker 1: ironic romantic image, the swashbuckling trader besting the mob.
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  Speaker 2: It is very, very hard to do.
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  Speaker 1: I'm Barry Ritolts, and on today's edition of At the Money,
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  Speaker 1: we're going to discuss why it's so difficult to buck
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  Speaker 1: the crowd. To help us unpack all of this and
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  Speaker 1: what it means for your portfolio, let's bring in Michael Mobison,
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  Speaker 1: head of Consilient Research at Morgan's Stanley's Counterpoint Global Division.
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  Speaker 1: He's also the author of a somewhat infamous paper, Contrarian
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  Speaker 1: Investing the Psychology of Going against the Crowd. The perfect
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  Speaker 1: expert for today's topic. Let's start with the easy question,
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  Speaker 1: why is it so damn hard to fight the crowd?
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  Speaker 2: Survival might be number one, Blame would probably be number two,
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  Speaker 2: but I'd say more seriously, Barry. You know, when we
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  Speaker 2: think about asset prices, and you mentioned buying, you know,
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  Speaker 2: buying low and selling high. Asset prices are meant really
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  Speaker 2: to provide us with information, but they often influence us.
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  Speaker 2: And that's I think the most difficult thing for us
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  Speaker 2: to get around is that when things go up, we
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  Speaker 2: naturally want to buy, and when things go down, we
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  Speaker 2: naturally want to sell, and so doing something different than
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  Speaker 2: that is very, very challenging.
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  Speaker 1: So I want to talk about market efficiency. Is it
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  Speaker 1: safe to say that the market the crowd is right
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  Speaker 1: most of the time?
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  Speaker 2: Probably? Is? I think the way that I think about
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  Speaker 2: market efficiency is really the notion of wisdom of crowds.
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  Speaker 2: And when are crowds smart? You need three conditions diversity
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  Speaker 2: so heterogeneous points of view, aggregation, some way to bring
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  Speaker 2: that information together. Exchanges do that perfectly, and incentives, which
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  Speaker 2: are rewards for being right in penalties for being wrong.
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  Speaker 2: So that's the wisdom of crowds. Well, we know there's
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  Speaker 2: the madness of crowds too, So how does that come about?
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  Speaker 2: And the answer is when one of those three conditions
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  Speaker 2: are violating. By far the most likely to be violated
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  Speaker 2: is diversity. So rather than us thinking independently, we correlate
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  Speaker 2: our views and so that's I think the biggest thing
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  Speaker 2: we need to think about is when are we all
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  Speaker 2: thinking the same way? When are we all standing on
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  Speaker 2: the same side of the ship. There's a fascinating dimension
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  Speaker 2: about diversity. By the way, as a side note is
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  Speaker 2: you can lose diversity in a system and nothing happens.
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  Speaker 2: Happens in ecologies as well, but just a small incremental
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  Speaker 2: change and all hell breaks loose. So this wisdom of crowds,
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  Speaker 2: of madness of crowd is not like a straight line.
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  Speaker 2: It's sort of a sort of a nonlinear function, which
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  Speaker 2: is really interesting and part of why it makes it
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  Speaker 2: so surprising and difficult for us to deal with.
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  Speaker 1: There are evolutionary reasons why going along with the crowd
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  Speaker 1: is a preferred emotional setting for us. Cooperative primates rather
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  Speaker 1: than fighting against the dominant trends explain well, if you.
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  Speaker 2: Think about primates and humans in particular, one of the
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  Speaker 2: main reasons we've been so successful from an evolutionary point
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  Speaker 2: of view is because of cooperation. And cooperation means that
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  Speaker 2: we work together. So being part of a group is
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  Speaker 2: incredibly powerful, and being outside the group is incredibly dangerous.
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  Speaker 2: So this is something that's deeply rooted in how our
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  Speaker 2: species has evolved over time, and so that is a
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  Speaker 2: you know, the ability to stand outside the group is
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  Speaker 2: actually something that's quite difficult to do just from a
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  Speaker 2: fundamental evolutionary point of view.
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  Speaker 1: And this is in a cultural issue. What you're really
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  Speaker 1: referencing are deep seated psychological reasons for wanting to seek
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  Speaker 1: safety in numbers.
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  Speaker 2: I'll mention Barry one experiment, famous experiment I think really
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  Speaker 2: brings us into nice focus. Solomon Ash back in the
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  Speaker 2: nineteen fifties did these experiments on conformity. And this setup
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  Speaker 2: was pretty simply at seven people around the table, for example,
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  Speaker 2: six where his were in on the experiment with him.
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  Speaker 2: Seventh person was a subject, and he gave him a
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  Speaker 2: very trivial task, you know, matching lines, and they go
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  Speaker 2: around on controls to get one hundred percent right, and
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  Speaker 2: then Ash would signal to the confederates to give the
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  Speaker 2: wrong answer. And the last person is the subject and
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  Speaker 2: they go around the table and the question is how
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  Speaker 2: often does the last person actually conform with something that's
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  Speaker 2: obviously wrong? And the answer is a pretty high percentage
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  Speaker 2: of time, about three quarters of people at some point
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  Speaker 2: said something like that, and then about a third of
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  Speaker 2: the answers were basically conforming answers.
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  Speaker 1: So that's cool, and.
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  Speaker 2: You know Ash wrote this up. But if you fast
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  Speaker 2: forward about fifty years, Greg Burns down at Emory University
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  Speaker 2: did the same experiment but put people in fMRI machines
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  Speaker 2: so you could peer into their brains to see what
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  Speaker 2: was going on on as they were doing this. Now,
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  Speaker 2: the task he had was slightly different, but same replicated
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  Speaker 2: the findings. But here's the thing so interesting. People did
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  Speaker 2: conform right at the same rate, roughly speaking, But for
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  Speaker 2: those people who remained independent, by the way Ash, twenty
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  Speaker 2: five percent remained independent. Same thing when the Burns study,
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  Speaker 2: for those people remained independent, the part of their brain
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  Speaker 2: that lit up was the amygdala. That's your fear center right,
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  Speaker 2: fighter flight fighter flight center right. So for you to
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  Speaker 2: stay independent, you had to overcome that sensation of fear
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  Speaker 2: to get to the other side, and that's difficult for
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  Speaker 2: us to do. So the amigdal is actually a key
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  Speaker 2: ingredient in all this. And so just to say that
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  Speaker 2: you mentioned neurologically, there's a barrier at us doing this
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  Speaker 2: because your brain is telling you, your brain is screaming
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  Speaker 2: at you, don't do this.
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  Speaker 1: So it's interesting we talk about fight or flight because
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  Speaker 1: the language around this is violent. Quote by when blood
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  Speaker 1: is in the street, fight, the tape buck, the trends.
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  Speaker 1: What does it say about the psychology of contrarian investing
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  Speaker 1: that we have such violent language to describe it.
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  Speaker 2: Well, if you just think about language, you know, we
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  Speaker 2: use metaphors a lot, not just in investing, but we
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  Speaker 2: use them in sports and so on and so forth.
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  Speaker 2: And the war metaphor, which is used quite a bit,
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  Speaker 2: actually is all about struggle and all about conflict. And
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  Speaker 2: so in a sense, what we're saying is for you
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  Speaker 2: to be a contrarian, you have to overcome this struggle.
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  Speaker 2: You have to deal with this conflict, which is very
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  Speaker 2: difficult to do. So I just think that, you know,
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  Speaker 2: it's a natural mapping on this thing being so uncomfortable
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  Speaker 2: for all of us and a struggle for the rest
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  Speaker 2: of us.
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  Speaker 1: So let's talk about the organizational constraints against going against
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  Speaker 1: the majority, including career risk. What is it that institutionally
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  Speaker 1: prevents us from fighting the craft.
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  Speaker 2: One of my favorite ways to think about this is
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  Speaker 2: a distinction that I think Charlie Ellis popularized, founder Grantish
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  Speaker 2: Associates and just a luminary in our industry, and he
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  Speaker 2: talked about the business versus the profession of investing. The
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  Speaker 2: professions about generating excess returns. The business is about gathering
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  Speaker 2: ass and Charlie's point was, you know, yeah, it's the
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  Speaker 2: good business to have a good profession, but sometimes the
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  Speaker 2: business becomes dominant, right, And so an example would be
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  Speaker 2: when an asset class is hot or an industry is high,
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  Speaker 2: you start launching funds trying to raise capital because people
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  Speaker 2: want that, but you know them may not lead to
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  Speaker 2: the best long term results. So I think that first
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  Speaker 2: that first tension ends up being a really big one.
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  Speaker 2: And then career risk is to your point, right, if
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  Speaker 2: you're out there and you're wrong, even for a relatively
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  Speaker 2: short period of time, people are going to think you're
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  Speaker 2: nuts and you risk losing your job. And so no
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  Speaker 2: one really loses their job if they're doing what everybody
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  Speaker 2: else is doing, or you least sort of lay low
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  Speaker 2: a little bit, and as a consequence, that reduces your
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  Speaker 2: career risk.
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  Speaker 1: Right. That reminds me of the famous Canes quote worldly
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  Speaker 1: wisdom teaches us it's better for reputations to fail conventionally
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  Speaker 1: then succeed unconventionally. Is this exactly what he's getting at.
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  Speaker 1: It's exactly what he's getting at. And by the way,
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  Speaker 1: that everyone should read this.
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  Speaker 2: It's chapter twelve of Kynes's book, and it actually there
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  Speaker 2: are a couple of sentences that precede that quote that
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  Speaker 2: are worth highlighting as well. So he says long term
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  Speaker 2: investors who, by the way, promote the public interest, he says,
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  Speaker 2: will come under will come in for the most criticism,
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  Speaker 2: especially if they're being overseen by committees or managed by
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  Speaker 2: boards or banks. And he says, and they're going to
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  Speaker 2: be viewed as eccentric, unconventional and rash against the average opinion.
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  Speaker 2: And by the way, if and when they're wrong, and
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  Speaker 2: they're going to be wrong, sometimes there is no mercy whatsoever.
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  Speaker 2: So then he finishes with that line that flourish what
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  Speaker 2: you just said, which is, hey, you know, you're better
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  Speaker 2: off just conforming what everybody else is doing because you're
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  Speaker 2: not going to put yourself in line for that sort
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  Speaker 2: of really painful exposure. So now the flip side of that,
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  Speaker 2: which is obvious, is you're not going to be able
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  Speaker 2: to generate the excess returns. Right, So this is the
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  Speaker 2: this is the challenge.
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  Speaker 1: Knes was an index So who knew when the crowd
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  Speaker 1: is w What does that suggest is going on behind
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  Speaker 1: the scenes when most of the thinking about a particular
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  Speaker 1: asset class turns out to have been facing the wrong direction?
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  Speaker 1: What does that really tell us?
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  Speaker 2: There's a line from Seth Klarman, founder of Boutpost, which
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  Speaker 2: I love and I think it gets to the heart
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  Speaker 2: of this question. Carmen says value investing, which is really
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  Speaker 2: all good investing. Value investing is at its core the
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  Speaker 2: marriage of a contrarian streak and a calculator.
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  Speaker 1: Right.
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  Speaker 2: So the contrayering streak says, we want to examine the
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  Speaker 2: other side of the issue. If everybody's bullish, we want
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  Speaker 2: to see the barish case. Everybody's bearish, you want to
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  Speaker 2: see the bulls case. But of course, being a contraller
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  Speaker 2: for the sake of being a contraer's not a good
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  Speaker 2: idea because the consensus is oft and right. So if
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  Speaker 2: the movie house is on fire, by all means, run
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  Speaker 2: out the door, don't run in the door. Right, So
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  Speaker 2: this is the first thing just to think about that
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  Speaker 2: and then the second component is the calculator, and the
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  Speaker 2: calculator says, because everybody's so excited or because everybody's so distraught,
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  Speaker 2: the asset price has become unduly expensive or cheap. And
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  Speaker 2: the combination of those two things, I think is where
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  Speaker 2: the magic lies. Now. Ben Graham wrote about this, of course,
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  Speaker 2: in The Intelligent Investor. He had this metaphor of mister Market.
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  Speaker 2: Buffett is repeated this, Warren Buffet's repeated this many many times,
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  Speaker 2: where mister Market is this person that has highs and
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  Speaker 2: lows and sometimes excited and sometimes pessimistic, and he shows
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  Speaker 2: up every day and says, Barry, I'm going to offer
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  Speaker 2: you a price. It may be way too high or
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  Speaker 2: way too low, and you have the option to either
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  Speaker 2: buy or sell, or to ignore them altogether. So I
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  Speaker 2: think that's a very nice way for us to think
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  Speaker 2: about that. The mister Market metaphor is, you know, sort
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  Speaker 2: of a quaint thing, but in many ways it captures
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  Speaker 2: the essence of what we're talking about today.
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  Speaker 1: Let's talk about investor expectations. How do they play into
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  Speaker 1: the concept of contrarian and investing.
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  Speaker 2: Yeah, So the point is that from time to time,
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  Speaker 2: the madness of crowds takes over and people become unduly optimistic.
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  Speaker 2: And so we think about the dot com peak for instance,
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  Speaker 2: or even recently things like the spack boom and so forth,
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  Speaker 2: they become unduly pessimistic. Easy to say in retrospect, but
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  Speaker 2: March two thousand and nine, SMP gets to whatever six
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  Speaker 2: seventy earnings power a lot higher, and as a consequence,
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  Speaker 2: expectations become unduly high, which is an opportunity for you
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  Speaker 2: to sell, or they become unduly low, which is an
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  Speaker 2: opportunity for you to buy. And I would just say
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  Speaker 2: the main thing that to underscore this point from the
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  Speaker 2: outset to bring all the ideas back together is one
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  Speaker 2: of the biggest mistakes people meet is failing to distinguish
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  Speaker 2: between fundamentals and expectations, right, and they're separate things and
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  Speaker 2: they should be thought about separately. So from time to time,
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  Speaker 2: expectations to run way too modest. Fundamentals are much better
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  Speaker 2: you should buy, And the inverse is true as well.
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  Speaker 1: So to wrap up, it's very hard to fight your
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  Speaker 1: own emotional comfort zone and bet against the crowd. Humans
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  Speaker 1: evolved as a cooperative species, and your gut instincts and
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  Speaker 1: evolutionary psychology wants to stay in the safety of the herd. Sure,
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  Speaker 1: it looks like there's glory in being a contrarian. For
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  Speaker 1: most of us, it's just too damn hard. I'm Barry Retults,
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  Speaker 1: and this is Bloomberg's at the Money