The Contrarian Bandwagon: A Paradox Explained

When it comes to investing, does the term "contrarian" mean anything these days?

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Looking back at the market over the past few years, it appears that the band Radiohead was particularly prescient when it declared that "down is the new up." That's because at some point during the downturn—nobody knows exactly when—being unfashionable became the most fashionable thing an investor could do. 

Fortunately, for those who keep track of buzzwords, this phenomenon even has a nifty name: contrarian investing. This strategy, which involves taking a skeptical view of market trends, is hardly a recent invention—longtime practitioners include Warren Buffett and Legg Mason's Bill Miller—but it appears to have become increasingly popular as of late. And as mutual fund managers and average investors alike jump onto the contrarian bandwagon, something quite paradoxical has happened: By nature of becoming a bandwagon, it's no longer contrarian. Contrarian, it seems, is almost becoming the new normal.

"Anecdotally, yes, I do think I hear [the term] more, especially by people who try to give investors advice," says Jeff Tjornehoj, Lipper's research manager for the United States and Canada. "I'm sure that people can make a really good claim that everyone should be contrarian. Well, if that were true, there wouldn't be any contrarians. The whole point of contrarian investing is that you're not following the herd."

This interest in contrarian approaches is not hard to understand in the aftermath of a plunge that left investors furiously scrambling in one very vague direction: away from the market. "It has a certain intellectual appeal that you are ahead of the pack, that you are not merely getting the same old advice that everyone else gets," says Tjornehoj. "There's some emotional [reaction] that says you're better than the rest."

This holds true even during periods of strength; after all, who doesn't want to be smarter than the competition? "I think many people like to call themselves contrarians because it sounds [trendy]," says Steve Lehman, comanager of the Federated Market Opportunity Fund. "It sounds as though it's the opposite of naïve."

[See Confessions of an Alleged Market Timer.]

Ironically, though, many contrarians are now finding themselves hitting the wall. "Talk about drawing the short straw: Generating a list of contrarian ideas for 2010 is no easy task with nearly every domestic and foreign stock category gaining more than 20 percent in 2009 and their fixed-income brethren not far behind," Morningstar analyst Michael Breen says in his recent article "Contrarian Investment Ideas for 2010."

Tjornehoj reaches the same conclusion, albeit by different reasoning. After a period of sharp and prolonged swings, the market, in his view, lacks strong momentum in either direction. "It's kind of hard to be a real contrarian at this point because . . everything looks fairly priced," he says. "Without momentum, you have no contrarians. In other words, I think the term is getting thrown around a lot but isn't very useful at this point."

[See How to Navigate a Slow-Growth Economy.]

So there you have it: the contrarian movement's two-part dilemma. First, what exactly does it mean to be contrarian in the current market environment? And second, as investors rush to lay claim to the title, how can you tell the real contrarians from those who have just latched onto the popularity of the term?

As for the second part, the answer appears to be that you'll know them when you see them. Lehman, for example, is a vocal opponent of the buy-and-hold mantra that has long governed the fund industry, and his approach of frequently shorting also cuts against the industry's standard operating practices. "True contrarians are pretty easy to spot because their positions are generally ridiculed," he says.

The first question is a stickier one. "The word contrarian: What does that mean?" asks Guy Pope, manager of Columbia's Contrarian Core Fund. "To me, it means going where there's a high degree of pessimism. And then you get into: How do you define pessimism? And I do it by price; and so stocks that are trading close to their lows over the past 52 weeks, I think, display that degree of pessimism."

But to a certain extent, words like "pessimism" and "contrarian" are little more than catchphrases. For investors looking to diverge from market trends, the real problem isn't finding a contrarian manager. It's finding a good one with a coherent strategy. "Just buying an idea because it's contrarian or being shunned is probably not a good investing strategy," says Pope. "A lot of people will say they're contrarian—that they have that philosophy—just like a lot of people say they're a growth investor or they're a value investor. . . . But then the next step is [asking], 'Well, OK, what is your process?'"