Buy the stocks everyone hates
Anger blinds your judgement and leads to unwise investment decisions. Cool your boots before buying, says John Stepek.
Anger blinds your judgement and leads to unwise investment decisions. Cool your boots before buying.
"Never invest angry" is as close to a universal truth about investment as you'll get. Anger can be a useful social tool, serving to highlight and deter the transgressions of others. But when it comes to buying or selling shares, it merely clouds your judgement and makes you careless in the face of an indifferent Mr Market.
Given this, a contrarian might ask: how could you profit from the rage-induced mistakes of your fellow investors? That's exactly what Richard Peterson of research group MarketPsych has been working on, notes John Authers in the Financial Times. Peterson is interested in what happens when you invest in companies that happen to be the focus of a lot of investor and media outrage. The internet has made it fairly easy to measure media sentiment towards various stocks. Each year Peterson's team compiles an index of the top 100 stocks in the US "by media buzz" and then buys and holds the 20 stocks with the "highest average media anger" for one year (the buying process is conducted monthly, over the course of the year, and transaction costs are ignored).
If you had bought the stocks that were subject to the most media anger each year since 1999, you'd have multiplied your money more than 20-fold, compared with merely doubling it in the S&P 500. This finding that investing in hated stocks was a winning idea is repeated almost everywhere else in the world, including the UK (Brazil is the unexplained exception).
This makes intuitive sense. Contrarian investors often say that you should buy stocks others shun, but using anger as a metric brings this into tighter focus. A stock can fall out of favour because investors fear for its financial prospects, and often they are right to do so. Anger is a purer, less rational emotion in this context, which is what you want as a contrarian. If investors are angry with a firm, they'll shun it regardless of its financial outlook, which leaves an opening for those who are willing to look beyond the immediate outrage.
For example, people were right to be angry with car giant Volkswagen after the news that it had rigged diesel-engine emissions tests. But few analysts saw the scandal as an existential issue, and if you'd bought in October 2015, just after the scandal broke and outrage was at its peak, you'd be up nearly 40% by now, beating both the wider German and US markets (in euro terms).
What does this suggest about opportunities now? People are angry with big tech Facebook and Twitter both make Peterson's most recent list. As to the bigger picture, you could argue that many investors still hold Brexit against the UK meaning now could be a good time to buy.
I wish I knew what bonds were, butI'm too embarrassed to ask
When governments or big companies want to borrow money, they can do so by issuing bonds. Bonds are simply IOUs. A corporate bond is an IOU from a company, and a sovereign bond is an IOU from a government. Like any IOU, the bond has two key components: the amount of interest it pays each year (also known as the "coupon"), and the date on which the original loan (the "principal" or "par value") will be repaid. This is the "maturity date". Most bonds pay a fixed amount of interest, and thus the bond market is also known as the "fixed income" market.
A borrower who is a very good credit risk will be able to borrow at a low rate. So a highly trusted nation the US or Germany, say or a highly rated company such as Apple will be able to pay a low coupon. Less creditworthy nations such as Argentina, or small firms, will have to pay a higher coupon to attract lenders.
A bond is typically issued with a par value of £100. However, once it is publicly traded, its price will fluctuate. When people refer to bonds they normally talk about the yield, rather than the price. You will also see different measures of yield quoted. The "current yield" is simply the coupon as a percentage of the price. So if the bond pays out £5 a year and the price of the bond is £105, the current yield is 4.76%.
But remember that when a bond matures, it repays its "par value". In this example, while the bond sells for £105, when it matures it will only return £100. This shows why maturity dates matter if it matures in six months, rather than six years from now, then the return the investor gets will be very different. The "yield to maturity" describes the yield an investor will get if they buy the bond today and then hold it until it matures.
All else being equal, rising interest rates and inflation are bad for bonds. That's because as the rates available elsewhere rise, bond yields have to rise to compete which means that bond prices have to fall.