Contrarianism: Why 1 million lemmings might be wrong

These aren't lemmings..what's he talking about?

We aren’t lemmings..what’s he talking about?

Sceptical reader: – I like the idea of not having to work this cubicle, but surely if financial independence was possible, wouldn’t I already have heard about it?

Given they haven’t heard of it, most people assume that financial independence (FI) must be impossible. So they keep spending like drunken sailors on shore leave, creating a self-fulfilling prophecy. After all, that’s what everyone else does.

One issue we have in the UK is that, unlike the US, there is no FI movement of any size. So we have few home-grown examples to follow. The good news is this – if you have read this far, you already “get it” and are on the right path or you are open-minded enough at least to be intrigued. Either way, congratulations – you are the smart minority.

Following the path to FI means going against the conventional wisdom and against powerful forces to conform. Remember that no individual lemming ever got laughed at – it feels comfortable in the herd, bathed in the approval of our fellow lemmings, right up to the point where we go off the cliff edge.

It’s funny that we all learn the parable of the Emperor’s New Clothes at primary school and we all get it. How do we go from that savvy child to consumerist sucker with mortgage, cubicle job and an inexplicable interest in The X Factor?

Contrarianism comes easier to some people than others. The Escape Artist’s educational experience at a comprehensive school in the Fens of Eastern England persuaded him from an early age it was possible that the overwhelming majority of his peers could be wrong. Frequently.  From there, it was not a big leap to realise that a life strategy based on imitating them was going to be sub-optimal. This attitude is unlikely to win you any school popularity contests but hey, we have to play the hand we are dealt.

Conformity and group think continued at university where I did an economics degree. Not just amongst the students, but amongst the lecturers. This included being taught the Efficient Markets Hypothesis, rational expectations and other implausible extensions of dogma into macro-economics.

They say that progress in academia advances one funeral at a time. Economics is littered with hard sums and complicated graphs drawn by middle aged men in brown checked jackets with elbow patches, determined to avoid getting a proper job. Their models work only as long as they are kept away from the real world. They are built on ridiculous assumptions such as the obvious non-starter that all market participants are equally knowledgeable and act 100% rationally.

If you think that all equity market participants are equally knowledgeable and all act rationally I suggest you visit a few internet bulletin boards, investment forums or comments sections. There you will enter a world of angry rants, poor quality spelling and excessive use of emoticons. You will find many self-appointed experts on “whisper” stocks: loss making tech companies and AIM listed Bolivian copper mining companies proving Twain’s old adage that most mining investment opportunities comprise a hole in the ground with a liar at the top.

We pretend that fads, bubbles, crazes are the exceptions to the prevailing assumption of rationality. The more I see of the world, the more I am convinced that operating via biases, outdated folklore and herding are the rule not the exception to the rule. It’s in these areas of human misperception where all the interesting action and excess profit opportunities lie.

If you have been reading this blog and paying attention, you should by now have a good idea of why we find it hard to deviate from the crowd. It’s mostly down to evolution. It was by living in tribes and co-operating closely with each other that we moved from an intermediate spot in nature’s hierarchy (below sabre tooth tigers etc) up to the top of the food chain.

Living in a close community provided safety and a prehistoric version of a welfare state. If your neighbour might just make the difference between you starving to death or surviving based on sharing some scraps of food with you, you can see there might were some pretty powerful incentives to agree with them and offer the occasional compliment on how that whole rabbit-skin loincloth and mud look works really well for them.

Arguing with your tribe would have meant risking ostracism and hence almost certain death for all but the most self-sufficient of people. If you are thinking that all this is somehow irrelevant because it happened so long ago, bear in mind that we evolved over millions of years, modern humans emerged about 100,000 ago and witches were being burned in Britain up until the 1735 Witchcraft Act put a stop to the fun. The gene pool of East Anglia may have improved a bit since then but, based on my experience at school, I wouldn’t bet on it.

The modern world is vastly more complicated than the environment we evolved in. The more complex the world gets, the more decisions we need to make using mental shortcuts. That means more decisions made based on herding.

If you are interested in turning the insights above into cash, the equity market is an interesting place to observe the fun. Contrarianism has long been a core part of my investing approach. I don’t think you can be a true value investor without some degree of rational contrarianism. When I buy an individual stock, I am looking for resilient and long-lived quality businesses that offer value – where they are temporarily cheap for an identifiable but superficial or temporary reason.

When high-tech equities were at all-time highs in 2000, “old economy” stocks traded at giveaway valuations. There is no such thing as a completely “safe” investment but buying BAT on a 10% yield in 2000 is about as close as we will ever get. This investment gift was hiding in plain sight. “All” you had to do was sell those Muppet.com shares and do the opposite of everyone else. Easier said than done.

I was lucky to have encountered the 1999/2000 tech bubble at a formative stage. For me, this remains the defining example of the possibility that the market can be wildly inefficient and the conventional wisdom can be wildly wrong. And no, I won’t be buying Facebook or Twitter stock anytime soon, not at current valuations.

In financial markets, however, memories are short. There are strong institutional reasons for this. As the City got more and more competitive and a more lucrative yet unpleasant place to work, careers got shorter. Billions of dollars of capital are allocated by people in their early 30s that have not experienced a wide range of market cycles. This helps explain the current irrational exuberance in fixed income, especially high yield debt. Jeremy Grantham has the best line when asked what investors would learn from the 2008/09 financial crisis. He replied.In the short-term a lot, in the medium term a little, in the long-term, nothing at all. That would be the historical precedent.

Bullshit is not a commodity in short supply on Wall Street. We are invited to believe things that are just not true all the time. Financial media continually repeat the sales mantra that more information always leads to better investment decisions. The reality is that the best use for your newspaper or CNBC is as a contrarian indicator.  When I used to read the Sunday papers, the only use for the Money section was to look what the “experts” were touting and then do the opposite.

I have some friends with grown up jobs in the City. One in particular is an interesting source of misinformation. When I see him, I usually encourage him to give me stock tips. He puffs up with pride slightly every time. Then there may be a furtive tap of his nose and a glance around him as he prepares to hand down some priceless insight as to why I should buy some bust bank (2008) or mining fantasy (2011).

Bless him, I’ve never had the heart to tell him that the reason I’m so interested in his tips is that he has such a reliable track record in being wrong that he is a near perfect contrarian indicator. Bloody nice bloke though.

Contrarianism can only take us so far however.   Even Warren Buffett needs some Charlie Munger types around him. Because we are all human, we cannot rely on sustaining our contrarianism if we are isolated in a hostile consumerist environment. Like the guy held in solitary and water-boarded by the CIA, sooner or later, we are probably going to crack. That’s why we need to find our own tribe and get some moral support from like-minded friends.

10 comments

  1. Nice post.

    I also have a friend in the City that specialises in ropey stock tips. I’ve tried explaining my investment philosophy (income) but can see in his eyes he just doesn’t/can’t get it. He’s more interested in chasing that multi bagger.

  2. UTMT – Thank you. I agree – the beauty of focussing on income is that it forces us to think like a long term owner of an asset and stops us fretting about (inevitable) fluctuations in prices. If we focus on price falls, we will likely end up capitulating at the bottom. Good luck to your City friend – he will need it.

  3. Hi EA, enjoy reading your articles. I started down the FI route about 5 years ago after finding the excellent Monevator. RIT is also a good UK site. MMM, The Conservative Income Investor and Dividend Mantra are my favourite USA sites. However, not a single person in my circle of family friends understands that FI is both achievable and absolutely liberating. It takes a particular mindset and hardworking. My favourite quote from Bob Dillon goes something like:
    A man is a success if between the time he wakes up and goes to sleep he does what he wants.

  4. Jon – I also found http://www.mrmoneymustache.com via http://www.monevator.com. Both are excellent. Thanks for the comment. If you enjoy the articles, please tell others and send them a link to the site. Sounds like your friends / family could do with reading them!

  5. The trouble with being a contrarian is that it’s now main stream. I’ve hardly read a financial pundit over the last 5 years that doesn’t claim to be one. Even my 70 year old mother told me over Christmas turkey that she was a contrarian and was therefore investing in property.

    I look forward to the stock picker with the headline – “bah, bah, I’m in this with everyone else!”

  6. Fun post, as usual. It’s comforting to know that so-called “experts” are found to be wrong more often than a lay person making a guess (paraphrasing from one of your favourite books” Thinking, Fast & Slow). No one can predict the future and our future is inextricably tied to decisions and actions of the masses…a predictably irrational bunch. *sigh* So be it. At least we’re aware of it.

  7. Really enjoyed this one from start to finish. Nice work!

    Those economic models always irked me when I read about the assumptions they were based on. I am hoping that they’ve made some progress in that area now and have read more about behavioural economics which seem to fit more with how the real world works, did you ever learn anything about that at University or is it a relatively new field of study?

    I come from a sports gambling background and can confirm that herd biases are, unsurprisingly, massively in action there as well. Everyone backs the favourite in any given event, so all the bookmakers have to do is set the odds low enough on the favs so it is less than the correct probability, but high enough for the lemmings to still pile their benefit cheques on it. Every so often the fav will lose and the bookies clear up. That is pretty much all there is too it making money as a bookmaker nowadays, along with a bit of trading and accounting of course. Simply by taking the contrarian view and backing outsiders you stand a much better chance of making money*, if you were into that sort of thing of course ;)

    (*it helps to have some knowledge in a given sport as well)

    Good to find another tribe member to converse with, and don’t forget to dish out your mates reverse stock tips next time round ;)

    1. Thanks Firestarter. The bookies perspective is always interesting as their prices reflect the wisdom of crowds. In contrast, most Universities have a policy of ensuring that they teach nothing of any practical value. If you are interested in applying behavioural finance I would recommend reading stuff by Robert Shiller or James Montier.

      1. Thanks for the reccs. Heard of Shiller, not Montier. Will check them both out

  8. weenie1 · · Reply

    Great post! I’ve always been on the contrarian side in life – just a shame that I was a lemming with my debts for a long time! I only found out a few months back that FI was achievable for ‘normal folk’ like me and not just for people who have pots of money or are lottery winners! None of my friends (aside from my best friend) understand what I’m trying to achieve – they’re still chasing after the newer car and bigger house, to be like the Jones Lemmings!

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