When pessimism prevails, it’s probably time to buy
If one thing puzzles private investors more than anything else, it is the extraordinary capacity of the stock market to move in ways that appear to follow no discernible logic. ‘Profits Up, Shares Tumble’, or even ‘World War Declared, Stocks Rise’: such headlines understandably confuse the uninitiated. But in reality there’s nothing strange about this pattern of behaviour, and understanding it explains why being a contrarian — going against the thrust of expert professional opinion — is so often the key to the greatest investment success.
The reason markets often move in mysterious ways is that in any well-functioning market, prices are set to anticipate future changes, not to pass judgment on the status quo. Whether it is the outcome of wars, the onset of recessions or future sales of the new iPad, market behaviour is typically a function of how reality stacks up against prior expectations, not a verdict on reality itself. Sometimes markets are extraordinarily successful at foretelling the future, and at other times spectacularly hopeless. Many years ago Professor Paul Samuelson joked that markets have predicted nine of the last five recessions. The wisdom of that crack has been seen many times since.
When they do get things right, however, markets can do so long before conventional opinion as reflected in the media, at the boardroom table or in the land of punditry, has arrived at the same conclusion. For all the money and time they spend on research, this rule applies more to investment institutions than to almost any other field of professional activity. The sharpest turning points in markets invariably come when the majority of professionals, like the garrison at Singapore in February 1942, are expecting something completely different.
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