The Cautious Contrarian

By nature I would say I have a tendency towards pessimism. Hopefully the odd sleepless night is a price worth paying for a successful career in bond investing, however it does leave me worrying (there’s the pessimism) that I could miss out on opportunities when markets sell off. It takes a brave investor to buy when all around are selling. Recent market moves and a book I read at the weekend have brought these thoughts to the front of my mind.

The book, The Most Important Thing, written by Howard Marks (The Chairman of Oaktree Capital, not Mr Nice)  argues quite convincingly that being a sceptical contrarian (admittedly with robust credit analysis) is the surest route to long term investment success. It’s an enjoyable read (if you like that kind of thing), well written and thought provoking. One passage in particular stuck with me and left me thinking “what would Howard Marks be thinking at the moment?”.  In this passage he simplifies a bear market succinctly into 3 stages;

1. When  just a few thoughtful investors recognise that, despite the prevailing bullishness, things won’t always be rosy
2. When most investors recognise things are deteriorating
3. When everyone’s convinced things can only get worse

It feels to me as though we are currently in the third phase and if one were to follow Marks’s reasoning we should be looking to add credit risk in names we like. After all, he would probably point out, things can’t get worse (just as they cannot always get better in a bull market) forever.

Personally I would keep my powder dry for the moment and wait to see what happens in the coming days and weeks. We had a huge sell off in southern European government and financial debt on Monday but UK, US and European Equity indices all fell by no more than 2% – nothing to get excited about in equity terms. At the close of play yesterday the S&P 500 was only 0.5% lower than where it was in June, while the extra yield spread investors are demanding from 10yr Italian government debt over that of Germany is 100bps wider than it was then.

If European policy makers fail to come up with measures to shore things up soon it can only be a matter of time before the equity market heeds the warnings the bond market has been screaming. A significant equity market sell off, if it happens, would no doubt push spreads wider and create more of the opportunities that contrarian investors can wait around for years to pick up.