Why Blind Contrarianism Amid Recession Fears is a Risky Business

Peruse the blogosphere long enough and you’ll invariably come across the notion that fears of an upcoming recession -- which have increasingly grown louder as multiple analysts weigh in -- are overblown. Essentially, the contrarian response is that economic downturns don’t happen when everyone believes that such an outcome is likely. Rather, it’s when Wall Street has no care in the world that provides the true signal to watch out.

Inherently, the concept of seeing what others cannot or will not is incredibly appealing because it imbues our ego with an intelligentsia that is simply unearned. Billed the Dunning-Kruger effect, this groundbreaking psychological study quantified that individuals typically have difficulty understanding their own incompetence in certain disciplines or functionalities, thus leading to inflated self-assessments.

In other words, a particularly enticing profile exists for retail investors to believe that their own insights can outperform the systems and models that professional market analysts -- who may have received years or even decades of formal training and education -- broadcast to the public on a frequent basis. Such reasoning, if true, would elevate the lay observer to that of an expert.

But just how realistic is this perception that contrarianism -- that is, going against conventional wisdom -- is an effective tool in guiding investment decisions amid macro catalysts?

Lessons from the Crash of 1929

Though virtually every American investor is familiar with the stock market crash of 1929 which preceded the Great Depression, economists and historians to this day still debate the precise catalyst of this unprecedented catastrophe. Nevertheless, a consensus of expert voices will attest to a variety of contributing factors, particularly rampant speculation.

Prior to the crash, mainstream outlets pounded the table on the bull market, arguing (convincingly) that the equities sector had nowhere to go but up. Enticed by the prospect of easy money, everyday working households invested their savings into publicly traded securities. Many borrowed funds to acquire stocks, pushing prices well beyond their intrinsic value.

In hindsight, moving against the crowd was absolutely the right decision. Naturally, the 1929 crash and the Great Depression serve as the hackneyed evidential catalysts for the contrarian argument: colloquially speaking, zig while the masses zag.

However, it is also absolutely incorrect to assume that no prominent voices warned against the excess speculation of the Roaring Twenties. Specifically, economist Roger Babson, during a speech at the Annual National Business Conference on Sept. 5, 1929, declared that “sooner or later a crash is coming, and it may be terrific.”

Babson would later go on to found an advisory service on stock market trends, living a full life of 92 years. Admittedly, being a contrarian in September 1929 would have yielded profound wealth. However, the most prominent voice supporting the prudent thesis was a professional, educated one -- that is, a conventional source of wisdom.

What About the Great Recession?

Another page in the annals of American market history which internet influencers supporting contrarianism as its own guiding force point to is the runup to the Great Recession. Under this framework, commenters on public forums and social media platforms assert that very few saw the 2008 market crash and global economic meltdown coming. Indeed, many talking heads on business news channels were pounding the table on the bull market, just like they did in the 1920s.

But is this assertion accurate? Did no one provide any warning about the forthcoming pain that in hindsight seems all too obvious? It turns out, the Great Recession also had its Roger Babson moment.

Back in late February 2007, NBC News ran a story that former U.S. Federal Reserve Chairman Alan Greenspan warned that “the American economy might slip into recession by year's end.” What was remarkable about Greenspan’s warning was how prescient it was. Contrary to common misconception, the Great Recession actually started in December 2007, per data provided by Federal Reserve History.

Once again, a well-educated, highly trained professional -- and someone who has been in the public light for several years -- called one of the most devastating periods in modern U.S. history with pinpoint accuracy.

Yet you don’t see Greenspan hawking some dubious investment newsletter, replete with ominous music as he pitches the collapse of America -- but offering one stock that can save your family from financial despair. On the contrary, like Babson before him, Greenspan leveraged his educational and technical acumen and presented risk probabilities to the general public.

It’s Best to Avoid the Bling

Too many times, charlatans posing as investment experts present the alluring narrative that the dumb impressionable masses are always wrong. However, you, who happen to be listening to this all-important message, can exploit this behavioral tendency and simply move against the grain. By being a bold contrarian, you can trade with the insiders and get a leg up on Wall Street.

As appealing as this plotline is, it’s not a holistically truthful one. Whether it’s Roger Babson calling the 1929 crash or Alan Greenspan warning about the Great Recession, more often than not, the mainstream educated voices -- not the random musings of internet conspiracy theorists -- present the most prudent and accurate guidance.

Therefore, don’t immediately jump aboard the contrarian argument regarding an upcoming recession or major event just for the sake of being different or edgy. While reactionary contrarianism sometimes yields profitable results, your decision-making processes should ultimately be grounded in the fundamentals. And in many cases, those fundamentals are provided by mainstream, conventional experts.