Tuesday, August 19, 2008

The New Contrarian Investment Strategy:Preface and Chapter 1

The author starts with a relevant reminder that the bond market was devastated in 1982, when municipal rates had more than doubled to over 14%. He makes the point that at that time, people listening to the advice given by doom and gloomers to abandon the financial markets in favor of gold, silver and collectibles would have done poorly. Money managers were exiting stocks in droves at this time, when inflation was at its highest, precisely when they should have bought stocks. At that time, some of the best quality stocks were priced to return 25-33% on after tax profits. Despite the fundamentals of dividends and earnings increasing at faster rates than inflation throughout the decade, professional money managers were still selling stocks.

He shows research from 1971 to 1981 that demonstrates investment advisers' sentiments lag the market. They advocate playing the stock market's current direction. The problem with lagging the market is that analysts get brave at the wrong time and cautious at the wrong time.

He shows evidence of a widespread failure of the largest and best staffed money manager firms in spite of their training, resources, experience and intelligence. Dreman believes that much of the failure is due to investor psychology. He counsels that history has shown that when people act blindly in groups and consensus is at its greatest is when the largest errors are made. He sets the stage for future chapters by indicating he will show that being a contrarian and doing the opposite of the masses is a great strategy with good odds of making good money.

Dreman makes a memorable quote well worth repeating here: Napoleon once said that "in warfare, the psychological is to the material as three to one". Dreman observes that in the stock market, the ratio is as least as important as in Napoleon's observation of warfare.

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