Markets, Contrarianism, and Popular Opinion

I don’t want to give the impression that investing has much in common with gambling, but the nature of competition and the distribution of profits between players in the two fields have a lot in common. A parimutuel betting market such as horse-racing or sports-betting would be a much closer analogy, but I don’t think that’s as interesting as going with poker. In poker the players place bets on their cards and the outcome of hands, and chips are passed around between them. Given that unlike in equities markets, there is no natural appreciation of wealth in poker, the average outcome is zero (its negative when you include rake to the casino). The median outcome however, is a net loss because the outcomes are skewed widely between the winners and losers- nearly all active players lose money, with a handful able to consistently do very well by capitalizing on the mistakes of the rest of the player pool.

The consistent winners are playing in a manner different from that of the average player. They do not have the same betting tendencies, and they are able to reduce losses and increase gains relative to opponents. Similar to investing, a poker player would be unable to profit by doing the same thing that everyone else is doing. If nine players sat around a table and had the exact same betting patterns, in the long-run nobody would be able to profit given that in the long-run they will all receive the same cards and final hands at the same frequency. If their play mimicked average opinion of good play, which is what they are all aspiring to, they would all be playing similarly and would be in this net-zero situation.

A good player therefore, would play in a manner which average opinion would likely disagree with, and would have to make uncommon types of bets. In reality this seems to be the case, and many of the better poker players do things that most people wouldn’t do, or do things that most people would disagree with. The average player is generally very confused watching an expert play, and some of the best players often make bets that most people would find stupid or crazy.

Similarly in investing, as Keynes put it, the out-performers will “be eccentric, unconventional and rash in the eyes of average opinion.” They have to do what others don’t, as they will have to invest in stocks that are at least temporarily in low demand or which are experiencing dropping demand. This means that the majority of investors will generally find their picks stupid, untimely, and wrong, and they would probably be confused as to why those stocks have been chosen. Whether they purchase good or bad businesses, the out-performer has to consistently find underdogs and those which have been unduly judged. This almost guarantees stretches of under-performance for the eccentric stock-pickers in that popular opinion will often temporarily keep or push the price of their holdings down.

This brings us to the topic of popular consensus and its rapid flow through the internet, which has made it much easier to hear the opinions of others on pretty much any topic. While we all have great access to information now, we are all aware that many people tend to feed their biases by consuming the information they choose to and avoiding the facts they would prefer not to hear. People on social media and people such as myself who post their opinions online are generally rewarded with likes, comments of approval, and followers. You can quickly see the average opinion of any website’s followers by looking at the likes, and those who commented with the most popular opinion (whether accurate or not) were rewarded for their thoughts, and in receiving that positive feedback they probably felt vindicated and correct whereas disagreement may have produced the opposite. If you post a conservative comment on the WSJ you will be rewarded, and if you post a liberal comment on The Hill you will be rewarded as long as you agree with the average and popular opinion.

This likely affects every field, but it has a direct impact on the investing community that seems to go unnoticed by those in it. There are quite a few investment forums, including SeekingAlpha, the Corner of Berkshire and Fairfax (CoBF), the Value Investors Club (VIC), threads on Reddit and many others. Most of those platforms have a very large active user-base and have become very popular. In visiting each of them, it is very clear that there is a nearly perfectly negative correlation between the number of users and the rigor/quality of research. VIC has 500+ users, CoBF has 1500+, the value investing Reddit has 41,000+ and SeekingAlpha has 13 million+ and I also think that is the proper order in which to put them if you are looking at the quality of posts on each. There was a study on the average performance of VIC recommendations, and they were deemed statistically significant in beating the market by a few points. There are many good investors on CoBF with quite a few operating their own funds, with the Reddit group being much broader but also including professionals and SeekingAlpha just replicating the US population and so frankly on average not providing any use.

I don’t mean to slight any of them, because they are all well-intended and help to inform many individuals, but I find it highly ironic that seemingly contrarian investors choose to visit a large community in which to discuss their intentions to beat the active market which is comprised of the community they are speaking to. It is my opinion that on each of them, the more people that agree with a certain opinion or investment, the higher the chance that it will be a poor investment (if it meets popular opinion, it probably won’t be able to beat the average investor). Just to cherry pick one of many cases, the opinion of most investors on CoBF and Reddit of Valeant was very positive until things went downhill, mimicking that of the market as a whole. If you are looking for agreement with other investors, you will be making investment decisions at the exact wrong time, just as popular opinion agrees with you. The best investments often will not get likes or approval or agreeable comments, and if shared with the world the vast majority would find them in poor taste- that’s what makes them great investments.

This is why investment firms cannot produce out-performance simply by hiring all the best graduates, or even by hiring all the best investors. You cannot produce out-performance by consensus, and so trying to construct a portfolio at the agreement of 10 different investors would create a mess. Another relevant Keynes quote sums it up:“It is the one sphere of life and activity where victory, security and success is always to the minority and never to the majority. When you find any one agreeing with you, change your mind. When I can persuade the Board of my Insurance Company to buy a share, that, I am learning from experience, is the right moment for selling it.” This is one of the reasons that nearly all out-performing investment firms are run by very few people or a single person.

Similarly, I also think the number of followers one has is correlated to their agree-ability with popular opinion. Nobody cared much about Buffett when he was achieving his best returns in the first few decades of his career buying cigar butts, they only became interested when he became a large owner of “wonderful businesses”. It’s very easy for the average investor to understand and enjoy buying the best companies in the economy (although Buffett gets criticized at the top of every bull market when he isn’t buying anything and under-performing), and it is much harder for them to follow an Icahn or Schloss and understand/appreciate their methods. It’s much easier to attract eyeballs and likes doing what average opinion finds favorable. Although most investors feel this way, unfortunately we can’t all just buy Google and Amazon and expect to outperform.

I think this is one of the reasons Charlie Munger is widely unappreciated as an investor- he is nearly always explaining his non-consensus and unpopular opinions and often comes off as a pessimist despite generally examining reality. Most people frankly aren’t interested in listening to people who disagree with them, who call out their irrationality, or who publicly call the companies they own “deeply immoral sewers”. This is also why most investors and management dislike short-sellers- the good ones call out nonsense, fraud and overvaluation. Management has no interest in hearing it, and the fans of the company who own the stock will generally remain fans regardless of the opinions of the minority- as long as they remain the minority. If the company and stock continue to do well, most stockholders aren’t interested in the criticism and will let quite a lot slide by without worry and without assessing the validity of the criticism- the stock is up, who cares?

There are very few investors I would trust with my funds and who I follow or speak with, but they are not the ones on social media with a large following or who most people would agree with. They say things that people don’t want to hear, and they make investments that most people wouldn’t. They are highly focused and often correct when they have strong opinions that disagree with the market. The average investor would probably be disgusted by their portfolio and assume they are a novice- they would either see many middling to bad companies or good companies purchased at times when the market and therefore most people find serious issue in them.

The average investor who cannot understand these decisions is one of the nine poker players betting in the exact same manner that his opponents are, expecting to profit from doing the exact same thing that everyone else is doing- and when everyone agrees with him, how can he see any issue with his methods? This probably comes off as callous or mean to some extent, but that’s fundamentally the thought process that the average investor has and that the out-performer implicitly understands that the average investor has.

If everyone agrees with this second-level understanding, it ceases to be second-level understanding and all investors would go about trying to exploit one another by doing what the rest aren’t and finding value where it is ignored. The vast majority of investors however, will remain on the first mental plane and leave opportunity for the few who disagree with them.