The Defensive Team: Part II

"Do I still get to have my cake and eat it too?" many investors might ask of the relative industry strategies. "We see they provide impressive retums over time, but how good are they in down markets?" Very good in-

goes. Eamings, instead of growing at 25%, grow at 20%. The difference is devastating to the stock. Perceptions of its prospects change and the market unmercifully punishes it. Now, even excellent growth is met with skepticism, and any failure to meet expectations continues the pummeling. The combination of impossibly high expectations and the competitive and organizational problems (endemic to high and extremely profitable growth) take their toll.

But moving back from the "why" to the "how," lets look at another reason this approach can help you. Buying the lowest valued stocks in each major industry opens a much larger investment universe than is available using an "absolute" contrarian strategy. Investing in the absolutely cheapest stocks, no matter which of the previous methods you pick, gives the investor only the bottom 20% or 40% of stocks in the marketplace from which to select. With a relative industry strategy, you get a crack at the entire market.*

The advantage of the relative contrarian strategy is that you have far more diversification by industry than you do in the original contrarian strategies. This diversification should protect you from the unde erfor-mance that occurs when the most out-of-favor stocks and industries in the market are taboo. Thus, if groups like communications or biotech are headed for the stars, you will not feel left out. You will also not be positioned only in the most disliked groups that may unde erform for months or sometimes years.

Although the retums of the relative industry strategies are moderately below those of the absolute strategies, psychological pressure is often the determining factor that may recommend these new methods. It is difficult for individual investors, and even more so for professionals, to take unpopular positions for long periods, even if they are right in the end.

With the inane focus on quarterly performance, by some consultants and clients, a pro who lags for too long can easily get the ax. Tme, he or she may prove right, but all too frequently it is "dead right." For the individual, the psychological pressures to mn for the hills are difficult or impossible to resist. After all, it is the psychological pressures that keep people from following contrarian strategies in the first place.

New, Powerful Contrarian Approach 201 Figixre 9-4a

When the Bear Growls Industry - Relative

Bear Market Retums 1970 - 1996

□ Low P/D H Low P/CF Low P/BV Low P/E 13 Market

deed, as Figure 9-4a demonstrates. As with absolute contrarian strategies in chapter 7 (Figure 7-5), we measured the bear market retums for all the down quarters in the 27-year time period. Once again, all four strategies outperform the market handily in the 34 quarters when the market dechned. The price-to-dividend method again shines, declining only -5.3% quarterly on average in down quarters against -7.5% for the overall market. Similarly, Figure 9-4b shows all four relative industry strategies outperform the market in the 74 quarters of our study when stocks are heading up.

Next well tum to a number of issues important to shaping your investment approach.

Buy-and-Weed Strategies

In the preceding chapter we looked at the success of "buy-and-hold" strategies. A twist on this approach is to buy a portfolio of contrarian stocks and weed it periodically of stocks that move up to or above the

Figure 9-4b

When the Bull Roars Industry - Relative

Bull Market Retums 1970 - 1996

□ Low P/D /Low P/CF Low P/BV Low P/E \ Maricet

market ratios, or if they fail to perform as well as the market after a certain time. An overview of the studies indicated that retums normally diminished with long holding periods (ten years or more). Some methods (such as this) would thus raise overall retum above the simple buy-and-hold strategy.

While this strategy introduces transaction costs, they should be quite small, since you should, on average, have only a few trades a year. The pmning process should also allow you to maintain a portfolio of contrarian stocks with above-average yields. In any case, whichever "mechanical" strategy you choose, you should have a good chance of outdoing the market while taking below-average risk and spending minimal time making selections.

Where Do I Get My Statistics?

You might ask how one determines quintiles. Brokerage firms, advisory services, and financial publications often advertise long lists of