Contrarian Investing: The Power of Reversals in Stock Performance

Stock market enthusiasts have long been intrigued by the phenomenon of stocks that fall out of favor one year and then soar to incredible heights the next. This trend, known as “reversals,” can be a goldmine for contrarian investors looking to capitalize on opportunities.

Let’s take a closer look at one such example: Nvidia (NVDA). According to FactSet data, Nvidia has emerged as the star of the S&P 500 this year, with an impressive 214.6% gain as of Nov. 7. However, it wasn’t always smooth sailing for this tech giant. In fact, just last year, Nvidia was among the worst-performing stocks in the index, losing a staggering 50.3% of its value and lagging behind 475 other companies.

Nvidia’s dramatic reversal is indeed remarkable, but it’s not an isolated incident. This pattern repeats itself time and again in the stock market, offering valuable lessons for investors. Contrarian wisdom suggests that buying stocks at the bottom of the performance rankings can often yield significant returns.

To illustrate the power of these reversals, let’s examine the performance of the top and bottom stocks from last year within the S&P 500. The 25 worst-performing stocks from the previous year have seen average gains of 32.5% in the current year, while the 25 best-performing stocks have experienced an average loss of 0.4%. The Dow Jones Industrial Average tells a similar story, with last year’s worst performer, Salesforce (CRM), suffering a 47.8% loss. Yet, this year, Salesforce has emerged as the Dow’s best performer, boasting a year-to-date gain of 59.8%.

What explains these dramatic shifts from year to year? It boils down to investor sentiment, compounded by factors such as tax-loss selling and end-of-year window dressing. Investor sentiment is a powerful force in the market, with emotions swinging between extremes. When a stock captures investors’ optimism, excitement can push it to unsustainable heights. Conversely, when a stock falls out of favor, pessimism takes hold. In this contrarian dance, stocks that were once in favor tend to lose their charm, and vice versa.

In conclusion, the world of investing is full of intriguing patterns and opportunities. Contrarian investors have long recognized the potential in stocks that have experienced reversals in performance. By capitalizing on these fluctuations and defying conventional wisdom, savvy investors can position themselves for success. So the next time you come across a stock that has gone from zero to hero or vice versa, take note – it may be the perfect contrarian opportunity.

Tax-Loss Selling and End-of-Year Window Dressing: A Catalyst for Sentiment Swings

Tax-loss selling and end-of-year window dressing are two phenomena that significantly impact the sentiment surrounding losing stocks in a given year. While I have previously delved into these concepts in a separate column, I will provide a succinct summary here.

Tax-Loss Selling: Offsetting Capital Gains

Tax-loss selling refers to the practice of investors selling stocks at a loss to mitigate the impact of capital gains taxes. By offsetting some of their gains, investors aim to reduce their tax liabilities. As the end of the year approaches, this strategy tends to exert additional downward pressure on stocks that have already experienced losses. Consequently, it is reasonable to expect a potential rebound for these stocks in the new year.

End-of-Year Window Dressing: Avoiding Embarrassment

Portfolio managers engage in end-of-year window dressing to avoid the embarrassment of including losing stocks in their final reports. By selling off losers before the year-end, they strive to present a more favorable picture of their portfolios. Much like tax-loss selling, this practice contributes to the downward momentum of already struggling stocks. However, it is crucial to recognize that not every underperformer will necessarily experience a noteworthy turnaround in the subsequent year. Thus, despite the allure of selecting stocks from a list of annual worst performers, conducting thorough research remains essential.

To ignite your contemplation in this direction, consider the following list. It comprises the 50 stocks in the S&P 500 with the most significant year-to-date losses, further refined to include only those recommended by at least two investment newsletters tracked by my performance monitoring firm. The stocks are organized in descending order based on their year-to-date losses.