Thursday, August 24, 2006

Contrarianism: It's More Than an Investment Strategy, it's a Lifestyle

"I don't know why you say goodbye when I say hello..."

The Beatles, "Hello Goodbye"

In case you haven't guessed already, I'm a pretty independent thinking person, and have always sort of marched to the beat of my own drum. At first, I didn't like being an only child, I always wanted to have a little brother to play with. But I learned to appreciate the time I had on my own, and to make the most of it. There's evidence now that the more you "exercise" your brain, the more efficient it becomes, so I'm pretty happy that I spent all those lonely rainy days alone with nothing but my books and my thoughts.

I never was really interested in the outside world growing up, but there were two things that really stuck out in my mind. The first was the importance of spotting trends ahead of time, so that you could always stay ahead of the game, and the next was that no matter how good things were, they were bound to go bad, and no matter how bad things got, they'd get better.

A lot of people have made a lot of money viewing the world this way. It's the principle of contrarianism. As it relates to purchasing stocks, it's the strategy of buying steady performers that are out of the public eye or have fallen out of favour among investors for whatever reason, then waiting for the economic spotlight to shine on them, and sell them and make a killing. Then, while everyone jumps on the bandwagon, you find the next hidden gem.

But contrarianism is useful outside of the stock market: buying a winter jacket at the February end of season sale, taking the train when its en vogue to fly, going on trips down south in July instead of during spring break, etc.

I've also adopted the principle in my lifestyle: most people my age want to travel and skip from job to job. I've started a family, and found a job with a good pension plan and am staying put. I bought a bungalow when two-storey homes were popular. And I'm paying down my mortgage aggressively and limiting my debt while I hear stories about debt spiralling out of control everywhere while people are taking advantage of the increases in their home equity. Do people really think the good times are going to last forever, or do they just want to live it up now and deal with the consequences later?

In the 80s, your average Joe yuppie never thought the good days would end. Then the recession of the 90s hit and wiped out a lot of the world's equity. We are just now reaching the heights of the mid 80s. And once again, very few people are noticing that we're at the top of the hill and closer than we think to going over the edge.

Unlike most people my age, I don't believe that a world of unlimited credit and low interest will last forever. I know that rates will rise and that banks are going to tighten up, and I'm saving hand over fist right now to get ready for that time, while most people are happy to charge everything and build up debt like lemmings.

How much can interest rates mess up finances? Think about it this way. For every $100,000 you're in debt (mortgage), a 1% increase in your mortgage rate adds an extra $70 or so to your monthly payment. So if you've got a $200,000 mortgage and renew your mortgage at a 3% higher rate (entirely conceivable), that's an extra $420 a month in interest payments. And that doesn't count the extra you'd pay on your car loan, line of credit, credit cards, etc.

That's when the banks go for the kill. All of a sudden, your debt-service ratio is out of whack, and they know they're in the driver's seat, and won't negotiate your mortgage rate. So, if your credit is already maxed out, the bank starts protecting its investments, which is when repossessions and foreclosures come into play.

And when that happens, and I'm guessing it will happen in about 5-6 years at the current rate, possibly far sooner if we're subjected to further terrorist attacks, consumer spending will dry up now that there's no home equity left, there will be a mass-selloff, a surplus of inventory in the market and few people qualified to make purchases, which will drive down prices. Investors will flee the housing market, since the combination of higher interest rates and dangerously low equity will but them in the red. All those people on the informercials proud of the fact that they're carrying investment real estate while holding next to no equity ("Get rich in real estate fast! Make over 10,000 a month!") will be ruined. Book it.

By that time, I'll be free and clear and sitting on a pile of cash. And ready to buy your investment condo for 50 cents on the dollar.


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