We are paraphrasing the quote “Always Be Closing” from the acclaimed play “Glengarry Glen Ross” because we love the play (colorful language aside) and the art of contrarian thinking. To us, being contrarian is the antidote to overconfidence, which often leads to poor returns. For instance, we naturally question bold claims like AI being an immediate game-changer or the notion that Trump's administration is going to bolster American exceptionalism and deregulate markets, leading to a booming domestic market while also cooling inflation. We worry that tariffs, seen as a form of taxation, are not just the “Art of the Deal” and could spark trade wars and higher inflation. Similarly, encouraging European countries to develop their own defenses while reducing our role in international policing could have negative consequences. However, a cornered Putin could be even worse. We also wonder how many anticipated international stocks outperforming domestic ones after a “Make America Great Again” president was elected. It’s enough to spin one into a whirlwind of confusion and self-doubt.
As an aside, we discussed global stocks in our 4th quarter missive, highlighting that one of the best ways to remove doubt is to study fundamental valuation and history. The “true” value of an investment reflects the price paid, which in turn reflects expectations of cash flow and earnings. If you get caught up in politics, macro indicators, sentiment, news reports, or narratives without historical perspective, you will struggle. Question all you want as that is good and it will keep you from being overconfident, but you need a rule of thumb to harken back to and price and valuation is the primary tool one must use for investing, not narratives. Michael Cembalest refuted the emotional point of view very well in his “50 days of Grey” market commentary: “Here’s the interesting thing about the stock market: it cannot be indicted, arrested or deported; it cannot be intimidated, threatened or bullied; it has no gender, ethnicity or religion; it cannot be fired, furloughed or defunded; it cannot be primaried before the next midterm elections; and it cannot be seized, nationalized or invaded. It’s the ultimate voting machine, reflecting prospects for earnings growth, stability, liquidity, inflation, taxation, and predictable rule of law.” No matter what doubts you have, price performance follows rules and math over the long haul, not narratives. Narratives, in our opinion, lead to overconfidence and the stock market is far more than a simple story.
To our way of thinking, narratives occupy too much headspace in today’s investing landscape. The valuation of stocks that are cheap and have decent earnings growth should take up more of our thought process than juicy “story” stocks. Historically overvalued stocks can correct in price because market whims can change suddenly. Therefore, we aim to diversify into areas less prone to commentary shifts. Global stocks, as referenced last quarter, were discounted approximately two standard deviations below US stocks. We continue to hold these as fundamentals support this price point despite negative sentiment about foreign governments. Small-cap companies, despite a bad quarter, present a compelling investment case as they trade at a significant discount to large caps, with projected earnings growth of 38%, 46%, and 68% for the 2nd, 3rd, and 4th quarters of 2025, respectively, according to JP Morgan. Commodity-related stocks, which haven't performed well despite AI-related sentiment suggesting increased demand for commodities, are another area where we feel compelled to make a contrarian bet as we continue to question consensus thinking. These are all examples of how we try to diversify away from the “narrative” risk that seems to pervade financial media.
Now, on the contrary, could any of our positions work against us? Certainly! However, when one has a margin of safety in the price one pays for an asset, then the whimsical nature of stock market sentiment is less influential. Could trade wars and job cuts cause severe market corrections not foreseen by the market? Possibly! However, when we properly diversify, we own assets like fixed income, precious metals, hedges, and historically cheap stocks that oftentimes zig when the equity market zags. Then, when overvalued markets correct and head back towards proper valuation, we are able to invest in positions with a far better risk profile. The stock market is like water, in our observation, it finds a point of weakness and flows to level no matter what. The contrarian idea many misunderstand is that high priced assets are similar to dammed-up water. Small leaks can easily burst and run towards more level ground. We like standing on stable ground where water runs in a natural manner so we can easily move where opportunity is better.
Analogies about the stock market and nature aside, we think it is interesting that the positive narrative about the stock market has switched to negative so quickly. On January 29th of this year the AAII (American Association of Individual Investors) Bull/Bearish Sentiment was 34% bearish and it hit 60.4% on February 26th, with a historical average of 31%. Typically, when it hits this high of a number the return a year later is 10% or higher going back to 1987. This sentiment measure is best known as a contrarian indicator, so it fits our theme, but it is also best at extremes. The February reading was the third highest in the past ten years, so the significance of this reading carries more weight at these levels. We finish up with this to encourage our investors to cast a skeptical eye towards the consensus point of view. Diversification and value paid can protect one from the narratives of the market. We instead emphasize sticking to the fundamentals of diversified investing and let storytellers “wax poetic about things pathetic” to someone else, to quote Paul Westerberg.
P.S. Speaking of storytelling, last quarter we listed books we read last year and asked if anyone had other suggestions. We received a recommendation for The Premonition: A Pandemic Story by Michael Lewis and were not disappointed. If anyone else has any other books to put forward, please send them our way.
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