Food for thought: When to Be Contrarian

Financial markets are often seen as a reflection of reality, but in reality, they can be quite different. The reason for this is that markets tend to project out linear valuations based on recent trends, which means that they can become disconnected from the underlying reality. This is especially true in times of bull or bear markets when the market is either above or below reality.

The best time to sell in the market, therefore, is not necessarily when reality is bad but when everyone is doing well in real life. This is because the market has applied an exponential multiple for things to continue, and it is only a matter of time before the market starts to come back down to earth.

Similarly, the best time to buy is when we are in a depression, and a linear down projection is multiplied out. In this way, being contrarian can be a wise strategy because the consensus at extremes in financial markets causes the market to be at the furthest place away from reality, which then starts swinging back.

However, being contrarian is also wrong because you are sitting at a place that is also far away from reality in the other direction. The market moves in a pendulum, and so you benefit inversely. In other words, you need to be mindful of where the market is relative to the macro environment and what the consensus pricing is, and then decide whether or not to take a contrarian approach.

The key takeaway is that learning macro is not just about investing based on the findings themselves, but understanding where financial markets are relative to macro and what is the consensus pricing out linearly in which direction. At the extremes, being contrarian works well, but in the middle, the trend is your friend.

In summary, financial markets can often be disconnected from reality due to the linear projections they make based on recent trends. Being contrarian can be a wise strategy when the market is at an extreme, but in the middle, it's best to follow the trend. Understanding macro can help investors make informed decisions about where the market is relative to reality and the consensus pricing out linearly.