I spend a lot of my time trying to persuade traders that it's in their best interests to follow trends rather than opposing them and that trying to pick tops and bottoms in a market independently of clear signals from the price action, is frankly a mug's game.
Of course, financial markets are complicated, fluid in nature, and dynamic.
None of which lends itself to simple classification and rule following - effectively the markets do what they want to and we have to adapt accordingly.
So are there times when it's right to oppose the crowd or trend then?
Yes of course there are.
However taking a contrarian view needs to be approached in a sober frame of mind and we need to understand exactly why we are turning our back on the majority of our fellow traders, what the risk of doing so are, the likelihood of success, and the possible rewards.
The contrarian trade is usually the preserve of those with a few grey hairs and deeper pockets.
Traders who have been around a bit, who can sit on a position and wait for it to play out.
Traders who manage their risk tightly and who don't bet the farm every time they trade.
because they know that longevity in the markets and exposure to the maximum number of trading opportunities is the key to success.
So if you are a newbie, a novice, or anything other than an experienced trader opposing a trend or any other contrarian trade probably isn't for you.
However, there is nothing to stop us from looking around for opportunities while were are following the prevailing trends, because of course thanks to the ebb and flow of trader sentiment and the cyclicality of markets things change.
And by looking around for opportunities we are preparing for those changes and after all as the old army motto has it “failing to prepare is preparing to fail”.
Where might those opportunities be found?
We can look for what's out of favour or unpopular, for example, the graphic below shows the percentage change among S&P 500 sectors over the year to date.
Information technology, up almost +40% in that time frame is “the trend” but at the other end of the spectrum, we find the Financials sector down almost -4% year to date.
Now of course we can't overlook the fact that we had a US banking crisis as recently as March and that the issues that caused the crisis haven't gone away and in some cases, they may have got worse.
However, US regulators have moved to limit the downside or fallout from those events and though their firepower is not inexhaustible, they have made it pretty clear they will do what's necessary to keep the financial sector running smoothly.
So does that mean we should all rush out and buy the sector ETF or the stocks within it?
Certainly not, but perhaps it can give us some confidence that the downside is limited.
Of course, it's also true to say that the S&P Financials sector doesn't just include banks, there are insurance companies, exchange operators, business software and information service providers, investment managers, brokers and more within the sector.
On that basis alone it's not right to tar all the stocks in the sector with the same brush although that is often exactly what the market does.
So we have established that S&P 500 Financials have dramatically underperformed the market-leading sectors and the broader index.
However, we also know that markets tend to revert to their mean or long-term average performance. So at some stage Information Technology should sell off and sectors that have underperformed like Financials should recover.
Interesting then to note then that last week's Bank of America’s Flow Show report detected inflows into the financial sector.
Whilst a Credit Suisse strategy note highlights that S&P 500 Financials were trading on a PE below their 20-year average, relative to the broader index /other sectors.
“One swallow does not a summer make” of course, but with Q2 2023 earnings season fast approaching and with the biggest US bank JP Morgan, due to report on July 14th, might the stage be set for something of a sector rerating?
The information provided does not constitute investment research. The material has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and as such is to be considered to be a marketing communication.
All information has been prepared by ActivTrades (“AT”). The information does not contain a record of AT’s prices, or an offer of or solicitation for a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information.
Any material provided does not have regard to the specific investment objective and financial situation of any person who may receive it. Past performance is not a reliable indicator of future performance. AT provides an execution-only service. Consequently, any person acting on the information provided does so at their own risk.