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Inside the Market

David Rosenberg to investors: Be wary of following the herd Add to ...

If you want to hang with the in-crowd right now, you need to be bullish.

Look anywhere, and there’s more unbridled enthusiasm for stocks than there has been in a long time.

The Dow Jones industrial average is at record highs. U.S. equity mutual funds are seeing massive inflows. Bank of America strategists have created a buzz phrase by calling for a “great rotation” out of bonds and into stocks.

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The S&P 500 has risen about 9 per cent this year alone. Yet there’s little sign that investors are scared of a portfolio-bashing correction. The CBOE Volatility index, the so-called fear gauge that falls when investors are feeling calm and upbeat about stocks, sank to its lowest level since early 2007 on Monday.

“Almost every one I talk to is now bullish,” observed long-term bear David Rosenberg, the chief economist at Gluskin Sheff + Associates Inc., in a note to clients earlier this year.

Mr. Rosenberg has become a little less dire of late in his market prognostications. While having little conviction over the longevity of the rally, his investment team recently added some selective equity exposure, mostly U.S. dividend-growing large caps.

But, in a recent interview, he also had some cautionary words to those thinking about blindly following the herd: Be wary.

“When I take a look at history as an economist, I know that the consensus on any basic indicator usually gets it wrong about 80 per cent of the time. Which means that the consensus gets it right about 20 per cent of the time, and then you have to decide.”

Mr. Rosenberg wasn’t dishing out his current views on the market; rather, what it means – and what it takes – to be a successful contrarian.

It may be a lesson particularly worthy of attention right now.

The contrarian streak, he says, is not about being bearish – or bullish, for that matter. It’s an understanding that when there is a herd mentality, it often means all of the news is priced in.

“You have to have conviction, and you have to have courage. And without those two, you’re just not going to make it into the contrarian realm,” he says.

“The human condition is to be positive, optimistic, and bullish – and that’s just a basic human instinct. And in the money management business, it is extremely important at all times to be dispassionate and to understand that there are always times to preserve capital.

“There are other times it’s about appreciation and aggressive growth and just basic understanding of just where you are on this continuum of the business cycle and market cycle. You have to basically keep your emotions in check because money is a very emotional thing.”

Mr. Rosenberg cites a key lesson of Bob Farrell, a legendary strategist at Merrill Lynch: When all experts and forecasters agree, something else is going to happen.

Mr. Rosenberg gained fame in the past decade when he became one of the few economists who warned of the impending housing crash and credit crisis in the United States. Predictions of a looming financial disaster weren’t welcome on the Street at a time when investment bankers were cashing in massive bonuses and many thought the heady times would last.

The key for any successful contrarian, he points out, is that they must have high conviction in their calls that a particular asset class is mispriced. Such a position must be backed by sound analysis.

And it’s also important to fully understand where opposing views are coming from.

“As a contrarian you have a higher hurdle to clear because you are going up against a lot of other smart people on the Street when it comes to economic forecasting,” he said.

“Don’t forget ultimately you have to do something convincing and you are swimming upstream, so it just means your layers of analysis have to be that much more thorough, that much more complete.

“When you are going against the herd there is an extra onus on the contrarian to prove the case.”

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