This Week: Is It Time To Be Contrarian?

So far, volatility has ticked up this week, and the stocks that had been performing best all year (e.g. momentum, technology, growth, FANG) are underperforming this week, thereby leaving some investors wondering if it’s time to get contrarian.

Considering momentum and FANG-type stocks have been performing so well since last November’s election, and considering a new pundit comes out every day claiming the market is overvalued, and considering we’ve entered the final month of the year where talk of profit-taking and rebalancing is increasingly discussed, and considering some value stocks are arguably getting to “too cheap,” many investors are wondering: Is it finally time to be contrarian?

Regarding contrarian ideas, Eric Parnell offers some interesting perspective in this article: Anti-Amazon: A Favorite Investment Theme For 2018. Eric explains “the upside investment opportunity that I see for the coming year is not trading against Amazon, but instead taking the opposite side of the Amazon trade.” As an opportunistic value investor, Eric focuses some of his time and attention on areas of market inefficiencies created by the Amazon narrative.

Our Trading Models:

Our trading models (highlighted in the table below) use a combination of momentum (non-contrarian) and “dip-buying” (contrarian) strategies, and unlike long-term investing, our models have the luxury of using “risk controls” to exit trades that are moving against us, instead of buying something “cheap” and then watching it get much cheaper over the following months and years as many “value-trapped” long-term investors often struggle to avoid.

Aside from the risk controls (e.g. stops and macro factors) that help us avoid long-term value traps, our models also have the luxury of using complementary momentum and “dip-buying” strategies thereby minimizing the risks of being trapped in one style when the other is out performing for an extended period of time (i.e. growth and momentum have been beating the pants off value and dividend investments so far this year, as shown in the following table).

Trading Model Performance:

Per reader feedback, we’ve recently started including a table summarizing the performance results for our trading models. The table (below) shows actual client results after commissions and fees (I watch this every day, and now readers can see it as well). We’ll share additional information, including test data, with those interested in investing. For our weekly updates, we use only real-time results.

And not surprisingly, our momentum models (e.g. Felix and Athena) have been doing very well in recent months, while our contrarian “dip-buying” strategies (i.e. Holmes, and somewhat Road Runner) have been somewhat lagging. However, very importantly, our “Blended” approach has been performing well, outperforming the market as measured by the S&P 500 (SPY).

For reference, the results in the table above include all of the positions (10 for Road Runner and Athena, 16 for Holmes, and 20 for Felix), not just the specific stock examples we discuss in the Stock Exchange every week (and sorry Oscar, you have too many individual stocks and trades to be part of this approach). We’ve included six months of data since that is the shortest real-time record we have. All of the models are expected to perform well over longer time periods. Holmes, for example, has returned over 20% in the last eighteen months.

Also very importantly, our models (especially our “Blended” approach) tend to have a low correlation with the overall stock market, which can be extremely valuable for diversification and risk management purposes, especially if you suspect the great momentum rally we’ve been experiencing might soon come to an end, but if you’re still not sure about going completely “contrarian.”

Interestingly, Dr. Steenbarger offers some very interesting perspective on the concept of co-trading in this article, which he describes as, among other things…

“Co-trading features true collaboration.That means the sharing of ideas and resources, as well as coordinated work on personal and professional development…. The members of co-trading teams, however, are independent traders.”

In some sense, our Stock Exchange “characters” (e.g. Felix, Holmes, Road Runner, et al) are co-trading, as a team, on a weekly basis. However, more aptly, we hope this weekly Stock Exchange series is helpful to your development as an independent trader.

Expert Picks From The Models:

This week’s Stock Exchange is being edited by Blue Harbinger (aka Mark Hines). Blue Harbinger is a source for independent investment ideas.

Road Runner: This week I like NetEase (NTES). Are you familiar with this company?

Blue Harbinger: NetEase is a Chinese technology company, and it trades as an ADR on the Nasdaq. NetEase provides online media, games, and e-commerce. Why do you like this stock, Road Runner?

RR: As you know, I like to buy stocks that are at the bottom of a rising channel. And based on the following chart, you can see why I like NetEase.

BH: Interesting pick. My first reaction is one of skepticism because this stock is still up more than 50% this year (even after the sell-off shown in your chart), and it’s up about 650% in the last 5-years. Considering many investors are afraid the momentum/growth trade is about to slow, aren’t you at all afraid that you are “chasing returns?”

Road Runner: I am a trading model, not a person, so no I am not afraid. I have been designed specifically to avoid the type of emotional trading you are describing.

BH: Aside from my initial skepticism, I do see that this company’s revenue is growing dramatically in recent years, and it is profitable. Here is a look at the FastGraph.

RR: That information is interesting, but my typical holding period is about 4-weeks. I’ll be in and out of this stock before the company’s fundamental story plays out.

BH: Suit yourself Road Runner. Your strategy has been working. Personally, I’d rather do a lot more research before investing in a stock like this, but that’s why I am an investor and you are a trader. How about you, Holmes—what have you got this week?

Holmes: I have no picks this week. And when I don’t see anything, I don’t force anything. How about you, Athena—what do you like this week?

Athena: I bought Envision Healthcare on Monday 11/27.

BH: Envision offers healthcare plans to companies. Why do you like it, Athena?

Athena: As you know, I am a momentum trader, and my typical holding period is about 1-month. Based on the following chart, Envision has a lot of upside price potential.

BH: Honestly, I don’t know enough about this company to have a strong opinion. I don’t know if I’m impressed or disturbed that you and the other models can pick stocks so quickly, and then own them for only a few weeks at a time. Here is some fundamental data (in the following FastGraph) for you to consider, Athena.

Athena: Thanks for that information, but I’m a trader, not an investor, and Envision looks attractive right now.

BH: Well, at the very least I can say I am impressed with your performance in recent months, as shown in the earlier performance table. How about you, Felix—what have you got this week?

Felix: This week I am sharing my ranking of the top stocks in the Russell 1000. My top 20 are included in the following table. And as you know, I am a momentum trader, but I typically hold my positions for about 66 weeks—which is much longer than the other models. I exit when my price target is hit, and I use stops and macro considerations to control risks.

BH: Thanks for sharing that info, Felix. I noticed you’ve ranked Square (SQ) in your top 20. That stock has been on fire this year, and it’s been extremely volatile this week. I actually placed an options trade on Square earlier this week.

Felix: What was your thesis for that trade, Blue Harbinger? We’re not on opposite sides of this trade, are we?

BH: Well, first of all, if you don’t know, Square helps small businesses accept electronic payments through easy-to-use, low-cost hardware and software (i.e. they have a mobile phone credit card reader). The company’s revenues have been growing like wildfire, and they have a more room to run based on the size of the total addressable market. And to make things more interesting (and volatile), Square recently shared news that it was going to be facilitating Bitcoin payments. We wrote all about Bitcoin in this Stock Exchange about a month ago.

Felix: Thanks for that background, but why’d you place the trade?

BH: I’m not giving away all the details on my trade, but it was to generate income (the premium income available for selling puts was very high). We’re both bullish (to differing extents) on Square, but our timeline and objectives are different. My position expires in a couple weeks, you typically hold for around 66-weeks.

Felix: Interesting. Thanks. How about you, Oscar—what have you got this week?

Oscar: This week I’m sharing my top ranked ETFs among “high volume” ETFs. The following table includes my top 20.

BH: The US Oil Fund ETF (USO) stands out to me because we were discussing the oil market dynamics in last week’s Stock Exchange. It makes some sense to me that you’d rank it highly. You are into momentum trades, correct Oscar?

Oscar: Correct. And I typically hold for about 6-weeks at a time before I rotate into a new sector. Also, I use stops to manage risks, so if the momentum trade stops working, I’ll be out of my position long-before most long-term investors.

Conclusion:

Many trading strategies work great, until they don’t. This is why we prefer to use a blended approach in combining several of our trading models to minimize the impacts of a shift in market leadership. For example, momentum has been leading the market higher this year (as shown in our earlier charts), but based on market performance so far this week, some investors fear the momentum trade may finally be slowing down, and it could be time to take a more contrarian approach. Our blended approach has a lower correlation with the market, yet continues to deliver strong returns. We’ll be sticking to our strategy, constantly gathering more data, and watching closely as the year comes to an end, to see if so too does the powerful growth/momentum trade finally slow.