Martin Pelletier: Don’t get fooled by taking the opposite position to everyone else simply because you think the collective have it wrong
By my nature I tend to be a bit of a contrarian which, if I’m not careful, can get me into trouble buying what is known in the industry as a falling knife or a value trap. On the other hand, adding low correlated and what could be temporarily underperforming assets into a portfolio can really help manage risk.
In today’s market environment I share the same concerns as the average investor about tariffs and trade war uncertainty. Individual investors haven’t been this bearish about the markets since November 2023, according to the latest survey by the American Association of Individual Investors.
This isn’t stopping equity markets, though, especially the tech heavy S&P 500, from reaching new highs.
And, while possibly nervous, most investors don’t want to miss out on the current market momentum.
So what is an investor to do?
Well, some are looking to private markets. According to the recent Hamilton Lane’s Private Wealth Survey nearly one-third of investment advisers plan to allocate 20 per cent or more of their clients’ portfolios to private markets in 2025, which is a 15 per cent increase over last year.
Globally, 73 per cent of institutional investors expect private markets to outperform public markets over the next five years, according to the seventh Private Markets Study published by Aviva Investors.
The issue is that investing in such markets can be dangerous and difficult for the average investor, as their money is locked up for a long time and there can be limited transparency on the actual investments being made. They also usually have to meet certain compliance requirements, such as being a sophisticated or accredited investor (someone with a net income of more than $200,000 in the past two calendar years, or net financial assets of more than $1 million). This is why it pays to get professional advice that can help with private equity selection in addition to looking at other alternative investments such as hedge funds and even direct commodities.
One area as a contrarian that is getting my attention is the bond market, which has underperformed the greater part of the past five years, especially at the longer end of the curve. Take a look at the iShares 20+ Year Treasury Bond ETF (TLT) that is down nearly 40 per cent from levels back at this time in 2020. What is really getting our attention is the level of short interest in this ETF is now at all-time highs, indicating bets are heavily positioned for its continued decline.
We think the U.S. tariffs could initially have a near-term inflationary impact, which long dated bonds are more than factoring in. However, as time sets in, higher import prices could impact the U.S. consumer. This could shrink the economy and force the Federal Reserve to lower interest rates at a faster clip, which would be beneficial to long duration investments such as the TLT ETF. This reversal could also happen a lot quicker than many expect, especially if there is any catalyst to cause the current monster short position to unwind.
Timing the market is impossible to do, but timing risk isn’t, as all you have to do is look at what the options market is pricing in. The level of complacency currently is quite high, as short volatility bets are now at levels last seen back in July 2024 when the market dropped by as much as 10 per cent. The rolling 20-day average of the equity put/call ratio has also now fallen to the lowest since July 2023.
This means it is a good time to buy puts and sell calls on your underlying position(s). We have recently done this trade on the Russell 2000 and S&P 500 index, resulting in embedded downside protection and capped upside capture. We also own the Simplify Hedged Equity ETF (HEQT) which does a rolling three-month put-spread collar offering a similar profile. This means one can stay invested in the S&P 500 but now have some downside protection in case something unexpected causes a correction to happen.
Finally, we really like structured notes (debt obligations with a derivative component that adjusts the security’s risk-return profile) as a partial equity replacement. For example, we just did one on U.S. Blue Chip stocks (companies such as Verizon, Citigroup, Morgan Stanley, Valero Energy and Qualcomm) that has 100 per cent downside protection and will pay out an annual 8.8 per cent return should these stocks collectively deliver a positive return any time over the next seven years. While this is taxed as income, the gains are tax deferred until the note’s autocall feature is triggered, and we also tend to hold these types of investments within registered accounts.
The trick to being a contrarian is not to get fooled by taking the opposite position to everyone else simply because you think the collective have it wrong. This is where Danish philosopher and poet Soren Kierkegaard offers some good advice: “There are two ways to be fooled: One is to believe what isn’t true, the other is to refuse to believe what is true.” Therefore, do the homework to seek the truth or at least add a bit of fool insurance in the event you get it wrong.
