Contrary About Contrarians

It's that time of year again. Last night us analysts hung up our stockings and left some milk and cookies by our inboxes before taking a long winter's nap. We were hoping for that special something when we arrived the next morning…and our wishes came true! Consensus market forecasts are here! (Actually, some of us would have preferred a Playstation 3, but what can you do?)

Most major economists and forecasters have published their outlooks for 2007. It's still too early to make an official tally, but it's looking like the majority of bigwig economists are expecting another positive single-digit stock return for the year.

Our loyal readers will know why this is significant. If a consensus believes something will happen then by definition of standard market theory it becomes unlikely because the information is priced in. Markets are discounters of all known information—and widely published economist forecasts surely fall into that category. Therefore, something outside of consensus expectation is a more likely outcome. This basic insight has played a key role in helping us successfully navigate bull and bear markets for years.

But it isn't an absolute. While it's true the consensus is usually wrong when it comes to market expectations, that doesn't mean automatically betting on the opposite is necessarily right. Being contrarian just for its own sake is a mistake. You still have to know something others don't; you've still got to glean some unique information and come to an accurate conclusion. This is an important distinction. Often the consensus can be on the right side of the positive or negative ledger, perhaps just not positive or negative enough. Here's a classic example of simple, and wrong, contrarianism:

Commentary: Surprising Contrarian Sentiment Hints Bull Market Isn't Done Yet
By Mark Hulbert, MarketWatch

The article says that we should be bullish because most are pessimistic. And to an extent this is true. But we still need proper, fundamental insights to prove that the pessimistic consensus is wrong. Things could actually be worse than what's widely thought! (It's not. Things are in fact much more positive than most believe at the moment.)

So, we know a single-digit positive stock market return in 2007 is less likely than alternative outcomes because that's the consensus. The next challenge is to forecast which side things will fall on—more negative or more positive? A cursory study of the consistent (and underappreciated) positive economic fundamentals we've reported on this site points to another potentially very positive year for stocks. (Note: we won't make an official forecast for another few weeks.)

Discount the consensus, but don't be contrary just for contrary's sake. See what others can't, find out how your brain might be tricking you, and fathom what the consensus cannot. That's the way to invest.