By James Thomson
Reading through the various tributes to the late Charlie Munger this week, it’s clear he was an investor with strong opinions that were often forcefully expressed.
But Chanticleer was also struck by the investment guru’s obsession with testing his own views.
“I never allow myself to hold an opinion on anything that I don’t know the other side’s argument better than they do,” he once said.
“We all are learning, modifying, or destroying ideas all the time. Rapid destruction of your ideas when the time is right is one of the most valuable qualities you can acquire. You must force yourself to consider arguments on the other side.”
It’s a lesson investors should take from 2023.
We entered the year with consensus telling us that recession in the US and global economies was likely, that tech stocks would further struggle under the weight of high and rising interest rates, and China’s economy would roar back.
Instead, economies remained incredibly resilient (probably too resilient for the comfort of central bankers), tech stocks have powered a global equity market rally, and China’s reopening has proven a dud, albeit one provided a nice tailwind to local stocks in the early stages of the year.
It’s a testament to the power of contrarian investing. Warren Buffett and Munger became famous for this during their careers, perhaps most notably when their conglomerate, Berkshire Hathaway, pumped $US5 billion into Goldman Sachs in the midst of the GFC for a profit estimated to be close to $US4 billion.
“We have a history when things are really horrible of wading in when no one else will,” Munger once said.
What views do investors hold about the year ahead? Where could they be wrong? And, how can you trade this?
Bank of America’s chief strategist, Michael Hartnett, gave us some great clues on how to think like a contrarian this week when he produced his “trades of the unexpected”. The list took the most popular beliefs from BofA’s latest global Fund Manager Survey, and found the contrarian play.
The most strongly held belief in the survey was that geopolitical risk will remain elevated; 89 per cent of fund managers say this risk remains above normal.
That’s entirely logical given wars in Ukraine, the Middle East and the prospect in 2024 of elections in countries accounting for 80 per cent of the world’s market capitalisation, 60 per cent of the world’s GDP and 40 per cent of the world’s population (in likely order: Taiwan, Indonesia, Russia, South Korea, India, South Africa, the European Union, Mexico, the United States, and Britain).
But what if these elections proceed in a more orderly way than expected? What if the Middle East finds a path to peace? In that case, Hartnett says the contrarian trade would be to bet on oil prices falling, given the commodity is typically seen as a barometer of geopolitical turmoil.
We get a hard landing
One of the strongest consensus views in the survey is that the global economy can dodge a hard landing; just 21 per cent of fundies expect things to get really nasty. So, how could contrarians play belief in a soft landing?
Hartnett, who remains a strong believer in a recession arriving, suggests betting on a widening of credit spreads and the forced selling of tech stocks.
One of his key trades for the year ahead is to look for what he calls “diamonds in the rough” in equity markets, arguing that the onset of any recession would be the time to buy the best stocks in the most beaten up areas of the market, including US banks and real estate investment trusts.
The Fed has to raise again
The growing consensus that the Federal Reserve is done raising rates is reflected in the view of fund managers; just 6 per cent expect higher short rates and 16 per cent expect higher long rates.
With inflation fading, that’s fair enough. But in the unlikely event the consensus is wrong, Hartnett says investors should sell bets that involve leverage, which could include unprofitable tech companies and private equity.
The RBA cuts sooner than expected
The BofA fund manager survey doesn’t go into investor views on the local economy, but the consensus of economists is that the Reserve Bank of Australia has more work to do to tame inflation, and cuts are likely in late 2024, or perhaps not until 2025.
But what if we get a sharper slowdown in Australia that forces the RBA to pivot sooner than expected? The traditional winners from rate cuts are interest-rate sensitive sectors such as infrastructure (Telstra, Transurban and APA Group, and among the last listed players standing) and consumer-facing stocks, although the latter would be tricky if economic conditions are really ugly.
Wilson Asset Management’s Matt Haupt has previously nominated healthcare as a sector that wins from rate cuts but isn’t too exposed to the consumer, naming CSL, Ramsay Health Care, Sonic Healthcare, and Cochlear as his picks.
The Magnificent Seven strike mischief
According to the survey, the most crowded in the world right now is to be long the Magnificent Seven tech stocks – Microsoft, Tesla, Amazon, Alphabet, Nvidia, Meta Platforms and Apple – that have driven most, if not all, of the gains on global markets this year.
But what if their dominance comes to an end?
It’s not impossible. While the hype around artificial intelligence is far from over, most of these companies do remain exposed to the consumer, and therefore a hard landing. Shorting these stocks is the obvious contrarian play, but Hartnett also suggests buying their institutional-grade tech bonds.
China or the UK recover
If the Magnificent Seven is the most crowded “long” trade among global fundies, the second-most crowded is shorting the Chinese market. The vast majority of managers are also heavily underweight British stocks.
The contrarian play is to go long these markets, with Hartnett suggesting mid-cap UK stocks are the best way to play the latter.
Small caps roar again
Bell Potter’s Richard Coppleson is among those who have noted the extraordinary underperformance of the small cap stocks on the ASX compared to their larger counterparts; the Small Ordinaries index versus the ASX 200 is now at its lowest level for eight years.
Reversals of this trend have long been expected by fund managers, but it simply hasn’t happened. But Coppleson is taking heart from a rally in the small cap Russell 2000 index, which is up 8.5 per cent in November, compared to a 6 per cent rise in the Small Ords.
Coppleson says small caps are a contrarian buy. “If most think that is the most ridiculous thing they have heard – then that’s good.”
Hartnett makes an important point about these trades of the unexpected.
“While these are mostly not ‘base case’ trades, they do serve to highlight potential hedging opportunities early in the new year for investors and asset allocators.”
The point is to remember the lesson of 2023, when consensus turned out to be very wrong, and remember the words of Charlie Munger. “Mimicking the herd invites regression to the mean.”
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