Two Contrarian Trades for the Coming Decade
January 28, 2010 by Nicholas Vardy
United States stock markets have just come off of their worst decade ever, with inflation-adjusted returns in the S&P 500 dropping as much as 30 percent. That’s a far cry from what investors were expecting at the turn of the millennium. Then, the Internet was creating paper billionaires overnight.
Fast forward 10 years and Nasdaq is still 40 percent below its peak. In addition, the Pew Research Center just designated the past decade as the “worst in 50 years.”
But, just as there was a technology bubble in 2000, today there is also a strong “pessimism bubble” about the U.S. economy over the coming decade. And like all bubbles, this one will eventually pop—as will the rising China bubble. Understanding this is the key to ensuring you don’t end up like investors who have spent the last decade waiting for Cisco to “get back up to $80.”
Rarely has the global stature of the U.S. been lower than it is today. A recent Washington Post/ABC poll found that 61 percent of the American people think the U.S. is in long-term decline. In another poll, 44 percent of Americans said that China was the top economic dog in the world, compared with only 27 percent favoring the U.S.
Much of the investment world holds the same opinion. In fact, the world’s top hedge fund managers are piling into gold, betting billions that the U.S. dollar is toast. Meanwhile, 17 percent of the U.S. workforce is unemployed, underemployed or has stopped looking for work.
And that’s music to the ears of contrarian investors.
Contrarian Trade #1: Buy American
After the financial meltdown of 2008, the greatest contrarian trade in the world became a bet on the U.S. But that’s exactly what I’m doing by shifting my own money and my clients assets back into the U.S.
First, investment is a game of expectations. Or as Bill Browder, formerly the largest investor in Russia, pointed out, Russia doesn’t have to turn into Switzerland for him make money. It just has to turn out better than people expect. In 1998, an investor I met in Russia said that he’d rather eat nuclear waste than invest in Russia. Yet, had he invested there, he’d have made 60x his money, just as Browder and his investors did.
Second, having lived abroad since 1991 has only strengthened my conviction that the global economy largely runs on U.S.-generated ideas. (This is not, as you can imagine, a popular position). The American Academy of Sciences estimates that 85 percent of economic growth in the U.S. is now produced by new ideas. In 2007, companies that were founded by entrepreneurs backed by venture capitalists provided 10.4 million American jobs and generated $2.3 trillion in revenues. That’s equal to the gross domestic product (GDP) of France.
Nowhere is the power of ideas more evident than in the case of decidedly unsexy U.S. manufacturing. On one hand, the media bewails that the American manufacturing workforce has shrunk by more than 40 percent since its peak in 1979, with 6 million of those job losses taking place over the last decade. But thanks to innovation and advances in technology, U.S. manufacturing output per worker recently hit an eye-popping $234,220 for each of that sector’s 11.6 million workers. Workers today produce twice as much manufacturing output as their counterparts did 20 years ago and three times as much as in the early 1980s. The U.S. steel industry—left for dead in the 1980s—produces more steel today than it did 30 years ago.
Contrarian Trade #2: Sell China
If there is one surefire way to make quick money in financial markets, it’s to bet on bubbles popping. Noted value-investor John Templeton made his first fortune over a 40-year period by betting on the rise of Japan. He made a bigger and quicker fortune by betting on the dotcom bust in 1999. I believe we are smack dab in the middle of a “pessimism bubble” about the U.S., much like the bubble about Japan 20 years ago, the Internet 10 years ago and China today.
Twenty years ago last month, Japan’s Nikkei index reached its historic peak of 38,916. In 1989, Japan was No. 1, as U.S. business school students pored over Japanese language texts and studied Japanese management techniques. A mere decade later Japan had been long forgotten and the world was in the midst of another frenzied bubble called the “New Economy.” Today, Japan and the Internet have been supplanted by the “China Miracle.”
Everywhere you look you see serious experts earnestly predicting the decline of the U.S. and the rise of China. And they will give you incredibly cogent, well-argued reasons for why you should listen to them. Many of these arguments I agree with myself. But the next time you read predictions about what the world will look like in 10 years, consider this. The most widely recommended stocks 10 years ago were America Online, Cisco Systems, Qualcomm, MCI WorldCom, Nortel, Lucent Technology and Texas Instruments. MCI WorldCom and Nortel went bankrupt. And if you invested in a portfolio of the others that survived, you’d have lost about two-thirds of your money. If the fates of Japan and Internet stocks are any guide, a similar fate awaits your “China strategy.”
Unlike many of those pundits who are so certain about what the world will look like in 2020, I never took that class on how to predict the future, naively opting for a course on Japanese joint ventures instead. But the two themes I’d bet on over the coming decade are to buy the U.S. and to sell China.
For the sake of my financial future, I hope you disagree.