Contrarian Optimism: The Secret to Outperforming the Market

During their latest episode of the VALUE: After Hours Podcast, Taylor, Carlisle, and Brewster discussed Contrarian Optimism: The Secret to Outperforming the Market. Here’s an excerpt from the episode:

Jake: Then Kevin’s last point, which is probably my favorite is that, he says that the market rewards optimism. And so, think about like betting on the S&P 500. Let’s say, you’re buying an index fund. You really are making an implicit bet that you have a lot of faith in the long-term prospects of the US economy effectively. You have to be optimistic to earn beta. And then, how about alpha? That usually comes from contrarianism, like, you need to buy when others in the marketplace are underpricing a security, for instance, and that often requires a contrarian view and for you to be right.

So, in Kevin’s construct, outperformance is made up of beta plus alpha, which is like this combination of contrarian optimism. And so, the most basic way to outperform is when sentiments really extremely poor, and when others can’t imagine that things are returning to good times. And so, you’re rewarded with not only the beta of the US economy, let’s say, growing, in this instance, but also with the alpha of being right about things being not as bad as they. He points out that a lot of value investors seem to have this view that is very contrarian, but it can also be natural pessimists. They’re always convinced that there’s a recession right around the corner, which means that they miss out often on the beta component due to that pessimism.

Actually, the beta component tends to be larger than the alpha component often in the return stream. I think he points out that Buffett is the best example of this word. He’s just like relentlessly optimistic, even though he’s also a natural contrarian. I mean, “Buy American. I am never bet against America.”

Bill: He didn’t buy in COVID.

Jake: Well, you know–

Bill: I’m not saying that as a criticism. I’m saying that I don’t know that he’s just naturally optimistic. I think he was rightly scared in that situation.

Jake: Yeah, but if you would have asked him, he would have still said like, “The luckiest kid is still the one born today.”

Bill: Yeah, no doubt.

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