There is always a fine line between genius and madness in markets — and that is particularly so when it comes to contrarian trades. Four situations (large and small) along these lines stand out for me in my past three decades of investing and trading.
Major, successful value positions in deeply out-of-favor equities always start with a contrarian point of view that is shunned and even ridiculed by others. Such positions sometimes vault to the profit target with only one available entry, while some begin in the red and can continue to go deeper in the red for a time. All along the way, the investor checks sales data, management, the marketplace and the like for clues that he or she is on the right path. And despite the market message at the time (which is that the position is crazy) the dedicated value player keeps the position and regularly adds to it.
One such contrarian play was wireless chip maker Qualcomm (NASDAQ:QCOM), which was a deep value stock for all but one year of the 1990s. Many investors could see the value of Qualcomm’s CDMA patents, and felt it should be worth three, five or 10 times the current value. But the stock was a “widow-maker.” It just would not budge, and people lost millions of dollars in the stock after giving up. Yet finally, one day in early 1999, the Finnish wireless handset maker Nokia (NYSE:NOK) decided to license CDMA technology from QCOM, and the stock went up 1000% in a year.
Another example was Apple (NASDAQ:AAPL) in the early 2000s. Near the bottom of the technology bear market, the computer and consumer electronics giant was trading for less than the value of the cash on its books. The market believed the company itself was essentially worth less than zero. Buyers were ridiculed. Many deep value investors hung onto the stock and purchased shares every month — and it still would not budge. Apple was another “widow-maker” for value holders. It was not until the company shunned the conventional wisdom by introducing a new line of products called the iPod that opinion began to change. And it wasn’t until 2004 that the value plays actually began to work out in a big way, as you can see in the chart above.
One of the most notorious, and later famous, positions along these lines was the “big short” in housing stocks and mortgage-backed securities. Everyone knows now that housing stocks and mortgage-backed securities crashed by 90% or more during the great financial crisis of 2007-2009. But value investors who had intuited that the housing bubble would crash actually started buying “credit default swaps” on mortgage-backed securities as early as 2004 and 2005, after the group was up as much as 600% in the prior five years.
The CDS was an instrument that allowed investors to bet against the mortgage-backed bonds, so it was considered a value play. But it was a horrible, terrible, “widow-making” bet for a couple of years before they ultimately worked out and made their persistently contrarian owners a fortune. I personally knew one of the investors later celebrated for being a genius for owning CDS on the mortgage-backed securities. And what most people did not know is that he lost many of his best investors, friends and even family members along the way around 2005, as they thought he had completely gone off his rocker and wasted their funds on a persistently wrong-way bet. He stuck with the bet and made a fortune — without them.
And finally, most recently we saw the trade in which the Counterpoint Options system saw value in shorting the VIX in late December last year, and bought VIX Jan. 16 puts all the way to the very top when the VIX was up 40% from its late November level. That was another value play that was ridiculed at the time, but worked out great.
The bottom line is that contrarian value bets rarely look smart when they are in progress in the early to middle stages, and even more so in the late stages. But they often work out in a mighty burst of energy, and that is what I suspect will happen before too much longer in the VIX.
InvestorPlace advisor Jon Markman operates the investment firm Markman Capital Insight. He also writes a daily swing trading newsletter, Trader’s Advantage which aims to capture profits of 15% to 40% and often as much at 100% to 200% in less than 90 days.
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