What If "What Everyone Knows To Be True" Is Wrong?
(March 26, 2011)
When the consensus is confidently weighted on one side of a trade or view, reality has a nasty habit of introducing blowback and/or unintended consequences.
In a followup to yesterday's entry A Contrarian Take on the Dollar's Demise , here are some other contrarian views culled from readers and recent news items. When does a contrarian view or bet become mainstream? Sometimes the answer is ambiguous. When do you look around and realize (usually with some dismay) that "everyone" now agrees with your once-lonely point of view?
Consider gold as an example. I am a fan of gold for the simple reason that it won't go to zero--something that cannot be said of purely financial assets. But as a technical observer, I can't help but notice just how lopsided the trade in gold has become.
According to the CFTC data, there are now 192,838 long contracts on gold and only 3,636 short contracts. That is a remarkably one-sided trade, and one that is technically ripe for a major reversal. When everyone agrees you can't miss on a trade, and punters are betting 50-to-1 that the trade can only go one way, then that's when it reverses and crashes.
As a technical observation, this is completely disconnected from all the fundamental reasoning behind owning gold. In other words, if you are one of the many readers who own gold long-term for peace of mind and insurance, then a 20% decline in gold is merely a "buy the dip" opportunity. For traders, it may offer an opportunity to gain on the downturn and then again on the inevitable upturn.
Correspondent Martyn T. recently made what I consider an important and contrarian point about the financial consequences of Japan's devastating earthaquake and tsunami.
So far you have not noted the way in which the Japanese insurers will affect stock markets. The Japanese government has long insisted that insurers prepare for a major event. This was expected to be an earthquake hitting Tokyo.
In other words, if the rebuilding and insurance claims will end up costing $300 billion, a significant chunk of that will come from insurers and re-insurers who will have to liquidate globally distributed assets such as stocks and bonds to raise the cash.
Let's assume the Japanese government will cover half of the costs of rebuilding and insurers will have to cover the other $150 billion. What will the liquidation of $150 billion in financial assets do to a vulnerable market? I hesitate to offer a prediction, but it is unlikely to be bullish.
Frequent contributor Dr. Ishabaka offered up this menu of other consensus views that "everyone knows to be true":
- the U.S. dollar will continue to decrease in value indefinitely
I am not at all sure that "everyone" knows Fenders beat Gibsons, but the list is certainly food for thought. As someone who has played both Stratocasters and my Gibson Les Paul Deluxe, I would say it's more like the difference between a cabernet and a zinfandel wine: sometimes you're in the mood for one or the other, but arguing about which is "best" is pointless, as both are superb but in slightly different ways.
Mark Twain commented on the dangers of consensus thusly: "Whenever you find yourself on the side of the majority, it is time to pause and reflect."
As I concluded yesterday:
When Bears have been eradicated, then the trade has become so lopsided that when it rolls over, it does so suddenly. When everyone agrees, then things become highly unstable. It's ironic, isn't it; on the surface, when everyone shares the same convictions and is on the same side of the same trade, things look rock-solid. Yet that very unanimity guarantees instability.
There is always someone on the other side of a trade, of course: someone originated the option or futures, and someone sold the shares that someone else bought. The problem arises when a "can't lose" trade rolls over, then there are no longer enough buyers to offset the panicky, underwater sellers who are overleveraged via margin or other forms of debt.
This is in effect what still plagues the U.S. housing market: there are still plenty of sellers in the wings, hoping to unload properties, and a dearth of buyers willing to gamble that "the bottom is in." Even worse, there is a dearth of buyers qualified to buy properties at today's prices. That will become even more of an issue as interest rates rise.
As a reminder of how things can play out at real bottoms: in the depths of the 1930s Depression, a Manhattan skyscraper was sold for the original cost of its elevators. In other words, the rest of the building was "free."
People talk about replacement cost as a metric of value in homes and buildings. In other words, this house can't drop much below $200,000 because it would cost that much to buy the lot and construct a replacement house.
That is another thing "everyone knows to be true" that is actually not true at real bottoms. Stocks can end up trading for less than the cash the company is holding.
We might conclude that being contrarian is simply considering very few possibilities
as being "impossible," especially when it comes to herd behavior and investments.
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