Question

How does the Goldman contrarian strategy work? You need to determine when you would trade to establish positions and when you would trade to close positions (provide specific dates). Think about when the prices of these stocks are likely to have changed the most to help decide when to open and close positions. Be sure to list the following:

Group of stocks purchased

Date and time stocks purchased

Date and time you would sell these stocks

Group of stocks sold

Date and time stocks sold

Date and time you would buy these stocks back

What are the risks? In other words, how could this go badly?

Answer 1

What Is a Contrarian?

Contrarian investing is an investment style in which investors purposefully go against prevailing market trends by selling when others are buying, and buying when most investors are selling.

Contrarian investors believe that people who say the market is going up do so only when they are fully invested and have no further purchasing power. At this point, the market is at a peak. So, when people predict a downturn, they have already sold out, and the market can only go up at this point.

Understanding Contrarian Strategy

Contrarian investing is, as the name implies, a strategy that involves going against the grain of investor sentiment at a given time. The principles behind contrarian investing can be applied to individual stocks, an industry as a whole or even entire markets. A contrarian investor enters the market when others are feeling negative about it. The contrarian believes the value of the market or stock is below its intrinsic value and thus represents an opportunity. In essence, an abundance of pessimism among other investors has pushed the price of the stock below what it should be, and the contrarian investor will buy that before the broader sentiment returns and the share prices rebounds.

According to David Dreman, contrarian investor and author of Contrarian Investment Strategies: The Next Generation, investors overreact to news developments and overprice "hot" stocks and underestimate the earnings of distressed stocks. This overreaction results in limited upward price movement and steep falls for stocks that are "hot" and leaves room for the contrarian investor to choose underpriced stocks.

Contrarian investors often target distressed stocks and then sell them once the share price has recovered and other investors begin targeting the company as well. Contrarian investing is built around the idea that the herd instinct that can take control of market direction doesn't make for good investing strategy. However, this sentiment can lead to missing out on gains if broad bullish sentiment in the markets proves true, leading to market gains even as contrarians have already sold their positions. Similarly, an undervalued stock targeted by contrarians as an investment opportunity may remain undervalued if the market sentiment remains bearish.

Contrarian Investing vs Value Investing

Contrarian investing is similar to value investing because both value and contrarian investors look for stocks whose share price is lower than the intrinsic value of the company. Value investors generally believe that the market overreacts to good and bad news, so they believe that stock price movements in the short term don’t correspond to a company's long-term fundamentals.

Many value investors hold that there is a fine line between value investing and contrarian investing, since both strategies look for undervalued securities to turn a profit based on their reading of the current market sentiment.

"Be fearful when others are greedy, and greedy when others are fearful," said famed billionaire value investor Warren Buffett. The Chief Executive Officer (CEO) of Berkshire Hathaway Inc. (BRK.A) is among many market watchers that recommend a contrarian strategy in order to profit from the market's giant upheavals. According to Deutsche Bank, going against the herd can lock in better gains for investors over time that a simple buy-and-hold plan, as outlined in a MarketWatch report. (For more, see also: 8 Contrarian Stock Picks for a Rocky Market: CS.)

Outperformance of High-Outflow Portfolio Picked Up in 2009

On an annualized basis, portfolios that buy the least-loved ETFs, which trade like stocks on an intraday basis, see gains of 12.9%, more than twice the 5.7% gain of a portfolio that buys funds with the highest inflows, as reported by MarketWatch. A recent study by Deutsche Bank, which analyzed the performance of exchange traded funds (ETF) following periods of higher inflows or outflows, showed that portfolios which bought ETFs with substantial outflows were rewarded with significantly higher returns than those that bought funds with heavy inflows.

Contrarian Strategies: Rich Returns

ETF	Annualized Return
High-Inflow	5.7%
High-Outflow	12.9%

The outperformance of the high-outflow portfolio accelerated dramatically in early 2009, at the start of the bull market which came directly after a bottom caused by the 2007–2009 housing crisis. At that moment, the S&P 500 hit a 12-year low, dragging investor sentiment down and leading investors to cut holdings. By early 2009, the market began to pick up, securing more than quadruple gains over the following 10 years.

Contrarian Approaches

Buffett is an example of a contrarian investor who bought up shares of beaten down companies during the Financial Crisis, including Goldman Sachs Group Inc. (GS) and General Electric Co. (GE).

Jeff Kleintop, global investment strategist at Charles Schwab, takes a contrarian approach to stock investing, as opposed to the ETF outflow approach.

"A shark attack could take a big bite out of unprepared investors' portfolio who don't rebalance," he warned, as cited by MarketWatch. The investor indicates that "to help avoid a shark attack," one should look abroad to international equities, reposition from a growth to value-oriented portfolio, and rebalance from small-caps to large-caps.

It's important to note that this approach, like all investing approaches, does not guarantee success. Further, in the case of a global recession and bear market, all assets could be hit hard. (For more, see also: 6 Small Tech Stocks That May Pay Off Big.)