Are you a permabear? Three red flags to watch out for

Contrarian investors are often seen as bearish because the market tends to go up over time. But if that bearishness goes too deep, you risk seriously damaging your returns. John Stepek explains how to avoid becoming a permanent-bear.

This article is an extract from John Stepek's book on contrarian investing, The Sceptical Investor, (published last year with Harriman House).

Few feelings in investment are as satisfying as being right, particularly if you have made a good call when everyone else was going in the opposite direction. It takes a fair bit of hard-headedness to hold your nerve in the face of all that opprobrium.

One big risk though, is that you react by becoming even more deeply entrenched in your world view. You fail to engage with the changing circumstances around you. You fail to recognise that your once-contrarian outlook is no longer a bold, minority take, but in fact the dominant paradigm. You end up wallowing in confirmation bias, and savouring your victory, rather than wondering about what happens next.

This sort of hubris and intellectual arrogance is one of the most insidious threats to the successful contrarian investor. So how can you spot it coming – and avoid falling prey to it? Here are three big warning signs.

1. You dismiss arguments that you don’t want to hear

As US financial writer Morgan Housel puts it: “The cosiest spot is under the warm blanket of ideology.” If you find yourself feeling relieved when a new piece of work from one of your favourite writers comes out, and you’re constantly putting it to the top of your pile, and avoiding research that doesn’t concur with your views, then there’s a problem.

Remember – what makes you feel comfortable rarely makes you money.

2. You are never, ever bullish

Bull markets are more common than bear markets. So contrarian views often have a bearish tinge, simply because the market tends to go up over time. Bearish views also appeal to those who like to identify as rugged individualists. They almost always sound more sophisticated, more worldly wise, and better informed than anyone else.

It’s surprisingly easy to sound like a hard-bitten realist when you’re talking about the end of the world. It’s much harder to pull off the “last cowboy” act, when all you’re doing is arguing tentatively that a grim-looking situation is about to get a little bit better, and so it’s probably a good time to buy.

As a result, it’s easy for sceptics – particularly the more moralistically inclined – to slip unthinkingly over the line into being ‘permabears’. If you find yourself falling into this trap, just remember – it’s easier to be the cynical edgy pessimist than the one who’s willing to take the risk of being labelled a cockeyed optimist for daring to look on the bright side.

Scepticism is healthy and will often lead you to be rightly bearish on certain markets or sectors. But cynicism is just a psychological defence mechanism against disappointment. Don’t mistake one for the other.

As John Stuart Mill put it: “I know that it is thought essential to a man who has any knowledge of the world to have an extremely bad opinion of it ...

“I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage, and wisdom is supposed to consist not in seeing further than other people, but in not seeing so far.”

3. You don’t mind being wrong because you “disapprove” of the market

An extension of the romanticisation of the bearish view is that a certain type of contrarian likes to see themselves as a heroic figure, wielding their sword of truth against the battalions of vested interests in their quest for economic and financial sanity.

Many bets against the market do start out from that desire. A contrarian sees something wrong – a neurotic national obsession with property, a deeply flawed financial system, a borderline fraudulent business model – and they make it their mission to argue against that ‘wrong’ in the market.

This can be a good thing. Many fraudulent companies have been hastened to a sticky and deserved end by hard-working short sellers.

But the market is not a morality play. If a position is costing you money, and you’re tempted to shrug it off because you’re outraged at the way the market works, then you need to get over yourself.

If you’re angry, write a letter to your MP. If you want to make money by arguing about your principles with people who won’t listen, then go into politics or the priesthood. If you want to make money in markets, then pay attention to the facts on the ground rather than your own prejudices.

Do not make moral judgements about markets (this does not preclude ethical investing by the way – if you want to avoid tobacco stocks or whatever, that’s a different topic).

I’ve seen many good investors and smart thinkers paralysed by their rage against “the system” and by investing on the basis of how the world should be rather than how it is.

Quantitative easing may be immoral and the source of a great deal of wealth inequality. Government subsidies can and do distort the market in favour of certain sectors. You don’t have to like it, and you can complain about it or even campaign against it – but if you want to make money, you have to take those facts into account whether you approve or not, and invest accordingly.

If you enjoyed this extract, you can pick up a copy of The Sceptical Investor here.

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