Wednesday, April 10, 2019

Stepek, The Sceptical Investor

John Stepek, executive editor of the UK’s best-selling financial magazine MoneyWeek, has written an astute book for retail investors. The Sceptical Investor: How Contrarians Bet Against the Market and Win—And You Can Too (Harriman House, 2019) suggests that the investor start with the admittedly incorrect premise that the financial markets are always wrong or, less baldly stated, that there are commonly pockets of inefficiency that can be exploited. It’s worth spotting and exploiting contrarian opportunities because, as George Soros wrote, “generally speaking, the more an investment thesis is at odds with the generally prevailing view, the greater the financial rewards one can reap if it turns out to be correct.”

Stepek does not recommend always doing the opposite of what the market is doing since the market often gets things right, which is why he prefers the term “skeptical” to “contrarian.” Skeptical investors consistently question assumptions, both the market’s and their own. They do the difficult work required to “identify when markets are overreacting to the point where the reward on offer for betting on the gap closing between market perception and reality more than justifies the risk of being wrong.”

Those who want to devote at least part of their portfolio to active, skeptical investing must not only resist the urge to run with the crowd but must also “avoid falling prey to the tripwires in [their] own mind[s].” Stepek summarizes some of the key findings of behavioral finance and suggests ways of keeping subversive emotions in check, such as thinking about the downside before committing to an investment, making as many decisions as possible in advance, and keeping a detailed investment journal.

The book has chapters on how to use the media (and not only the magazine cover indicator), the importance of intellectual humility, how to spot bubbles and what to do about them, and the dangerous temptation of making better forecasts. Re the last point, Stepek notes that you want to find situations where you don’t have to predict the future because the downside is pretty much already in the price.

The skeptical investor, Stepek warns, shouldn’t rush to catch falling knives. As he writes, “if you pride yourself on being a sceptical investor, then you should be extra sceptical of any company whose share price has just slid off the edge of a cliff.” He offers practical tips on how not to get suckered into buying stocks that will only continue to go down.

The book concludes with a way out for readers who decide that skeptical investing is more trouble than it’s worth: find a good contrarian fund manager.

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