Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

This article was originally published in The Telegraph.

THE trend is your friend. Most of the time, investors are better off assuming that a rising market will remain on an upward path and that falling investments will also continue to do so.

Turning points are, by definition, rare and if you try to catch them, you’ll invariably be early or late. But while you might not pinpoint a market’s change of direction with precision, you can improve the likelihood of being close.

The longer a movement continues, the more stretched fundamental measures of value become, the greater the chance that you will experience a reversal. You can stack the odds in your favour.

This is the modus operandi of the contrarian investor. Swimming against the tide might lose you money in the short term. But the more the pendulum swings in one direction, the further it is likely to move the other way in due course. In baseball parlance, it’s called waiting for the fat pitch.

The last week has seen three significant changes of tack in the markets.

The first has been in the UK, where the FTSE All Share index last week enjoyed its best five days since the beginning of January. The 3.1% rise in the UK’s blue-chip index was the best since the 3.3% gain notched up in the very first week of the year.

This has been a major reversal of fortune for UK investors, who have sat through a miserable first half of 2023. Having outpaced most other markets last year, albeit by moving sideways, the FTSE 100 has this year managed to edge just 2pc higher.

That has been a shockingly poor performance measured against the Nasdaq index’s 35pc gain, the 18pc enjoyed by the S&P 500 or the 9pc achieved by continental European markets. The odds of a UK bounce-back have been shortening all year.

The catalyst for the UK market’s U-turn was last week’s unexpected fall in the headline rate of inflation from 8.7pc to 7.9pc.

As investors scaled back their forecasts of where interest rates might peak, the property companies and housebuilders, which are the most obvious beneficiaries of a more benign monetary policy environment, experienced returns of more than 10pc. The trigger was unpredictable, but it was unsurprising that something would come along to prompt the rally.

This week has seen another notable change of direction. Chinese shares this week rose by nearly 3pc and Hong Kong was more than 4pc higher after the country’s ruling politburo agreed to measures to boost employment, to support the property market and more generally to breathe life into a pitifully weak economy in the wake of last year’s end to Covid restrictions.

Again, this was a sea change in investor sentiment towards Chinese shares that was becoming more and more likely. China has been an outlier for all the wrong reasons during the second quarter of the year.

Matching the S&P 500 between January and May, the CSI 300 index in Shanghai and Shenzhen is now underwater while the US benchmark is nearly a fifth higher year to date.

The third pendulum swing occurred in the opposite direction after both Netflix and Tesla failed to match investor expectations. Tesla warned that profit margins would be hit by its decision to lower prices to boost sales. The electric car maker saw its shares shed nearly a tenth of their value.

Meanwhile Netflix fell by a similar amount after announcing disappointing sales and earnings numbers and reduced guidance for the current quarter.

The sell-off of the two dragged the Nasdaq index more than 2pc lower. The results announcements were unanticipated but not the fact that tech stocks would take a hit. It was a salutary reminder that a market which has been dragged higher by a narrow subset of companies was vulnerable to the slightest whiff of failure.

The valuation of the US stock market has risen from 15 times expected earnings a year ago to about 20 today. There is increasingly little scope for disappointment when that amount of good news is already baked in. All three about turns might have been spotted by contrarian investors. UK and Chinese shares have been out of favour in recent months. Tech stocks have been all the rage. Nothing lasts forever.

Trending markets nearly always overshoot until their valuations are unsustainably extreme. They move too high in a bull market, too low at other times. A contrarian approach allows an investor to benefit from the margin of safety that protects an oversold stock or market.

Contrarian investing is not risk-free. There are very few successful contrarians because it is a difficult way to make money. Markets tend to go up in the long run, so betting against that upward path is to fight the odds. Contrarian rallies can also be explosive and short. Missing out on the early stages of one can be expensive.

The psychological anguish of going against the herd is real. It triggers the same area of the brain as physical pain. And contrarian investors risk falling into the value traps that wily Mr Market lays for them. Some investments are cheap for a reason.

But there’s plenty of evidence that being greedy when others are fearful and vice versa can pay off for those investors with the grit to stick with their unfashionable bets. And implementing a contrarian investment strategy is simple given the widespread availability of the numbers that are used to identify opportunities.

‘Dogs of the Dow’ is the best known of these, a simple dividend screen that buys the highest yielding stocks in an index and sells them when they no longer qualify on that basis. Other related approaches substitute earnings, sales or asset criteria to spot the market’s most out of favour stocks. 

The extreme valuations, in different directions, of the UK and Chinese markets and the technology sector did not guarantee the recent reversals, but they did make them more likely.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Please be aware that past performance is not a reliable guide indicator of future returns. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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