Going against the grain

Contrarian investing engages reason more than emotions and is therefore against our visceral instincts. When a sector captivates the imagination of investors, capital floods in, valuations inflate, and the margin of safety evaporates. In the 1990s dotcom boom, between 1995 and 2000, the NASDAQ Composite rose roughly 400%. Investors poured money into any company bearing a “.com” suffix, regardless of earnings, cash flow, or business model. Meanwhile, unglamorous sectors such as energy, financials, and old-economy industrials were systematically shunned. A contrarian who loaded up on ExxonMobil, Berkshire Hathaway, or Procter & Gamble in 1999, while the crowd chased Pets.com and Webvan, would have dramatically outperformed over the following decade.

The same dynamic played out before the global financial crisis of 2008. As housing-related assets and financial stocks consumed investor imagination, banks, mortgage originators, and structured credit vehicles generated enormous enthusiasm while the overlooked opportunities sat in plain sight. Commodities and emerging markets were deeply unfashionable yet subsequently delivered extraordinary returns. Jim Rogers, Marc Faber, and other contrarians who identified agricultural commodities and frontier markets as undervalued well before mainstream recognition captured multi-year bull markets that consensus investors missed entirely.

Fama and French demonstrated that cheap, unloved stocks have historically outperformed expensive, beloved ones over long horizons. Kahneman, Thaler, and others showed that investors tend to overpay for recent winners and abandon recent losers, creating the structural mispricings that contrarian investors can exploit. Research by Lakonishok, Shleifer, and Vishny found that overlooked stocks outperformed glamour stocks by approximately 10–11 percentage points annually over five-year holding periods in U.S. markets.

The charts below illustrate this thesis. In the dotcom era, the consensus bet on NASDAQ technology produced a spectacular rise and catastrophic collapse, while S&P 500 Energy was completely ignored but compounded steadily throughout. During the pre-GFC, US financials peaked and then cratered, while commodities and emerging markets (the contrarian trade) delivered dramatically superior cumulative returns, even after accounting for their own 2008 drawdown. The lesson from both periods is stark: Crowd enthusiasm is precisely what destroys returns. By the time a sector is widely loved, its upside is already priced in while its downside is not.

Illustrative reconstruction based on documented index performance (NASDAQ Composite, S&P 500 Energy, S&P 500 Financials, S&P GSCI Commodities Index). Not investment advice.

Warren Buffett’s “be fearful when others are greedy, and greedy when others are fearful” is apt in these times. And he practiced it with conviction. His purchase of American Express during the 1963 salad oil scandal, or his buying of Washington Post shares in 1973 when the media sector was reviled, generated some of the most celebrated returns in investment history.

The difficulty, of course, is psychological. Going against the grain means being “wrong” and looking foolish for uncomfortable periods before being proved otherwise. It is therefore a game that requires one to be not only stoic but also to be “thick skinned.”