Contrarian investing requires strong nerves, a good sense of timing and valuation. Going with the trend is a less stressful strategy. A contrarian must pick the moment just before a trend turns. Or, he must enter only when valuations are very much in his favour. Otherwise, he risks big losses.
Let’s simplify and assume a contrarian is interested in “long-only” because shorting is even more complex. Even for long-only positions, timing and valuation calls are tough. Leading indicators like the Relative Strength Index (RSI) and Stochastic Oscillators have high failure rates in terms of technical timing. RSI and Stochastic both flag overbought or oversold situations. But once a strong trend is in force, a market can remain overbought or oversold for very long periods.
Judging when valuation is low enough to enter in safety is difficult. Valuations that are already very low can swing even lower. In a big bear market like 2008-09 or 2001-2003, the contrarian must have both patience and deep pockets. He should be prepared to average down and hold losses over a long period.
Looking across sectors with a contrarian perspective, one could seek possible long positions in the most beaten down sectors and stocks. The biggest losers of the past year have come from Realty and Infrastructure. Both the CNX Realty and the CNX Infra recorded negative performances in calendar 2010. Many stocks in those spaces have underperformed the Nifty by big margins.
Unfortunately, when one examines specifics, both sectors feel uncomfortable. Technically, the indicators seem to suggest further downsides are possible. In terms of classic valuations, both look highly overbought than the Nifty. The CNX Realty has a PE of 23+ and P/BV of 2, while the CNX Infra has a PE of 28+ and P/BV of 3.4.
However, the contrarian might ignore this if he trusts the following logic. One thought is that accelerating GDP growth should trigger revivals. Across infrastructure, the problem has been a paucity of project finance (and policy risks). The financing at least, could ease. In Realty, the problems have been both lack of demand and lack of finance. Demand at least may revive if 2011-12 is a good year in terms of GDP growth.
Another point is that classic valuation ratios are very misleading in these spaces. In Realty, last year’s profits may bear no relation to next year’s profits if real estate rates rise. Infrastructure projects are always long-gestation and profitability jumps only once operations stabilise.
It could be wishful thinking to enter either area. I’d get interested in infrastructure only if the index dropped another 10 per cent, or if the valuation ratios improved dramatically. In Realty, I’d look for a bigger dip of around 20 per cent. But it’s now worth watching out for the contrarian possibilities in these two spaces.
The author is a technical and equity analyst
