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ARP Observations

Investment Rules: Pick your moments to be contrarian

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See all articlesThe Absolute Return Letter

Many moons ago, my then boss taught me the art of making the right noise at the right time. Go long and get loud, was his simple advice, and that advice has followed me ever since. His philosophy was simple. Smart investors never express what they truly believe in, until they have positioned themselves accordingly. When somebody goes on TV and claims to be bullish (bearish), he or she is already very long (short).

If long USD is already a very crowded trade, where is the buying power going to come from? Experience has taught me that these sorts of issues must be taken into consideration when engaged in portfolio construction.

Here is the tricky part. Being a contrarian doesn’t always work. I have learned over the years that is not enough to have a majority of investors subscribing to a certain view. You need a substantial majority to be behind that consensus for the contrarian strategy to work.

Secondly, it also makes a difference where you are in the cycle. I have found that the earlier in the cycle you are, the less likely it is that the contrarian view will work. Going back to the USD example from before, the USD index started to form a bull trend in mid-2014. Following a very powerful bull run that lasted about nine months, the USD index began to consolidate, and has moved sideways ever since.

The combination of large gains, more recent consolidation and a marketplace that is very crowded turns my contrarian instincts on. The only reason I haven’t made any moves yet is the overwhelming likelihood of a more hostile Federal Reserve Bank, as the US output gap continues to shrink.

Going back to my trend model, my current reading on USD is as follows:

1) Structurally: NEUTRAL to BULLISH
2) Cyclically: BULLISH
3) Behaviourally: BEARISH

Most of my structural trends are not particularly bullish or bearish for USD with one noticeable exception. The US workforce will grow by 0.5-0.6% per annum between now and 2050, whereas the European workforce will actually fall - by about 0.4-0.5% annually to be precise. All that is because of ageing – or because of the retirement of the baby boomers, as I call that structural trend.

This will lead to trend GDP growth in the US that is about 1% higher than that of Europe, assuming productivity gains are broadly the same on the two continents (which is a fair assumption). All other things being equal, that will lead to higher interest rates in the US and a stronger USD.

That said, in a perfect world, and for me to go head-on into a contrarian trade, I need at least two, and if at all possible all three, trend models to send the same signal, but they don’t in this case, which is why I continue to sit on my hands.

About the Author

Niels Clemen Jensen founded Absolute Return Partners in 2002 and is Chief Investment Officer. He has over 30 years of investment banking and investment management experience and is author of The Absolute Return Letter.