Contrarian investing: why emotions matter

When it comes to investment decision making, is there a place for emotion? You might be surprised to learn that a lot of the behaviour we observe in markets is emotionally charged with investors favouring information that supports their entrenched views.

The contrarian investors’ job is to be aware of the emotions involved in making an investment decision and to stand apart from them. That means considering how other investors might react in terms of pessimism versus optimism and being prepared to challenge accepted thinking. Be sceptical of ‘hot trends’ and stay open-minded when other investors turn their backs and walk away.

Often, investors become emotionally attached to stocks and the stories that underpin them – which can be dangerous. When an investment is highly valued and universally loved, even a small disappointment can upset the share price. It also means the expectation bar is set high – a company may need to produce dazzling results to exceed investors’ expectations.

So-called pariah stocks are also a product of emotional investing. Having been disappointed in the past, investors can fixate on earlier losses and be reluctant to acknowledge progress and signs of improvement. Contrarian investors take a closer look at stocks shunned by the wider market that tend to be overlooked and underestimated. Such stocks can be rational investments: there’s little good news reflected in the share price, meaning that even an incremental improvement can be ahead of expectations.

One well-known speculative ‘hot theme’ that investors had fallen in love with was Bitcoin. Launched in 2009, the cryptocurrency was seen as the next big thing, gaining a cult following of people who believed passionately in its story. The value of Bitcoin surged to $17k at its peak in December 2017. However, this explosive rise didn’t reflect any fundamental increase in its underlying value. A big attraction was Bitcoin’s finite nature – only 21 million Bitcoins were to be produced. But in 2018, a de facto parallel currency cast doubt on the idea of Bitcoin as a store of value. Since then, Bitcoin has been knocked off its perch, dropping to under $3.3k. To our eye, there is clearly an emotional element to the behaviour that drove these extreme movements.

In contrast, for centuries gold’s enduring appeal has been its ability to retain its purchasing power. We have exposure to gold via Newcrest Mining and Newmont Mining. Before our purchase, investors had punished the companies for overexpansion, since then both have taken action to get their house in order, by cutting costs and reducing debt. Often, such companies can be much more interesting than some of the fashionable alternatives. When it comes to investing, popularity really isn’t everything – and emotions can be a burden, not a boon.

Please remember that past performance may not be repeated and is not a guide for future performance. The value of shares and the income from them can go down as well as up as a result of market and currency fluctuations. You may not get back the amount you invest.

Please note that SIT Savings Ltd is not authorised to provide advice to individual investors and nothing in this article should be considered to be or relied upon as constituting investment advice. If you are unsure about the suitability of an investment, you should contact your financial advisor.