Contrarian Investing: Can it be paying to be a contrarian investor in a bull market?

When we talk of contrarian investing, we basically talk about stocks, sectors or themes that are currently out of favour of the market. If we choose companies from this basket, the returns, going forward, can be quite attractive. When we think of the economy and businesses, there are basically two sets of it.

One set comprises broader economy companies that follow a well-defined economic cycle, while the other set is consists of secular compounders. Broader economy companies tend to show good earnings growth when the economy grows and vice versa. On the flip side, the so-called secular compounders tend to be less cyclical, in the sense if the economy does well, they would show good earnings growth, while in fragile economic condition, they would be reporting a bit slower growth.

Now the question is: does it pay to be a contrarian in a bull market? Contrarian investing works for both set of investors, those who follow market regularly as well for those who follow it only at certain times.

The strategy pays off both in bull and bear markets. It depends entirely on stock selection. Contra investing can be highly profitable, but only at key turning points like the turn of an economic cycle or a company’s business cycle. Investors like Warren Buffett, Peter Lynch and John Templeton have many times mentioned how profitable the contrarian approach to investing can be.

As we all know “every disaster is an opportunity in the market.” So, when the market behaves irrationally, all the stocks begin to fall no matter how good their underlying fundamentals are. Such a fall in stock prices creates an opportunity for investors to buy good stocks at bargain prices. And when the market returns to normalcy, good stocks rally, as there is a huge demand for them in good times. That gives contrarian investors a great opportunity to sell those stocks and make multi-fold profits.

For example, when the Covid-19 pandemic hit the world, investors went on a huge selling spree and drove down the prices of almost all the stocks. Even the fundamentally strong ones were not spared. Now with support from the central banks stimulus and the government’s constructive measures, the situation has improved a lot. Government spending – be it in the US, China or India – on infrastructure has also increased. Sectors such as metals, cement, healthcare and realty – which have been suppressed for many years – are seeing an increase in stock prices. Besides, it is expected technology-enabled companies, select consumer name and some of the beaten-down real estate or capital goods companies can give good returns to contrarian investors in the current environment.

(DK Aggarwal is the CMD of SMC Investment and Advisors)