You Can’t Follow the Herd When You’re Investing

Lately, I was reminded on just how powerful the effects of contrarianism are when I came across an article titled You Win By Thinking Everyone Else Is Wrong that was penned by my American colleague Morgan Housel.

The article contained a really interesting table comparing the returns that certain groups of shares had for 2013. In the USA, analysts from Wall Street – the financial capital of the country – dole out ‘Buy’ and ‘Sell’ ratings for individual shares frequently and Morgan managed to tease out certain figures from these ratings that really deserve serious scrutiny.

Among the 10 shares with the most ‘Sell’ ratings on Jan 2013, the average return from the start of last year to 11 Dec 2013 was 75%. That’s remarkable, given that the S&P 500, a widely-followed stock market index in the USA, was up by ‘only’ 27.4% in the same period. How did the top 10 shares with the most ‘Buy’ ratings on Jan 2013 end up? Their average return was… 22%.

So, we have the most popular shares on Wall Street, the ones given the best ratings by some of the brightest financial minds in the USA, fail to keep up with even the average share in the country.

It’s not just in the States where popular investments end up disappointing.

Back in Feb 2012, investment management firm Franklin Templeton Investments polled a group of investors in Singapore for their opinions on the top three asset classes that would perform well for the year. Their choices were precious metals, non-metal commodities, and real estate. Shares weren’t even mentioned, but here’s a table showing the returns of the various asset classes for 2012.

Asset Feb 2012 Dec 2012 Change
Gold (precious metal) S$2183 S$2046 -6.3%
Silver (precious metal) S$43 S$39 -9.2%
Crude Oil (non-metal commodity) S$141 S$124 -12.6%
Commodity Price Index 196 182 -6.8%
Singapore Housing Index (real estate)** 247 256 3.6%
Straits Times Index (SGX: ^STI) 2,905 3,167 9%
The Singapore Housing Index data for Feb 2012 and Dec 2012 are for the first quarter of 2012 and last quarter of 2012 respectively.

Source: For Gold price, see Gold Price Network; for Silver price, see Index Mundi; for Crude Oil Price, see Index Mundi; for Commodity Price Index, see Index Mundi; for Singapore Housing Index, see Trading Economics; for Straits Times Index, see Yahoo Finance

The asset classes that local investors thought had the greatest promise turned out to be relative duds when compared to shares, as represented by the Straits Times Index.

Now here’s an interesting thing. The Straits Times Index had a poor 2011, dropping some 17%, which might have reasonably dampened investors’ expectations for local shares for 2012. How did the American shares with the most ‘Sell’ ratings in Jan 2013 fare in 2012? According to Morgan in his article, “Most of the companies analysts flooded with sell ratings earlier [in 2013] performed terribly [in 2012].”

Notice the similarity? It seems that, no matter where we are, there is a tendency for the markets to – in Morgan’s words – “always assume tomorrow will look just like yesterday, moving as a herd toward what is often the wrong conclusion.”

The late legendary global investor Sir John Templeton was famous for saying that “The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.” Or in fellow super investor Warren Buffett’s words, “Be fearful when others are greedy, and be greedy when others are fearful.”

The quotes from Templeton and Buffett are as contrarian as can be and they are both right. You simply cannot follow the herd when you are investing.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.