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KIM: Contrarian mind-set is key to unearthing opportunities

July 23, 2011

KimEditor’s note: Mickey Kim debuts as an IBJ investing columnist this week. Kim is the chief operating officer and chief compliance officer for Kirr Marbach & Co. LLC, an investment adviser based in Columbus, Ind. Kim’s column will appear every other week.

As in the first half of 2010, the U.S. equity market tested the confidence and resolve of investors in the first half of 2011. Our economy hit a soft patch and the sovereign debt crisis in Greece erupted anew and threatened to spread to Portugal, Italy, Ireland and Spain. The scars of 2008 and early 2009 are still fresh and investor confidence remains fragile. Investors are prone to quickly abandon “risk assets” (i.e. equities) for the perceived safety of U.S. Treasury bonds whenever fear bares its sharp fangs.

Fortunately, unlike the first half of 2010 (when the S&P 500 lost 6.7 percent), the U.S. equity market rallied strongly at the end of the second quarter, leaving the market in positive single-digit territory for the first half of 2011.

We were pleased that Kirr Marbach client stock portfolios significantly outperformed benchmarks during the first half of 2011, building on strong performance in 2010. The mutual fund our firm advises landed in The Wall Street Journal’s “Category Kings” rankings through much of last year, and, most recently, in its rankings for the 12 months that ended June 30, 2011.

The economy will likely continue to improve, but the recovery will be choppy, with setbacks and disappointments along the way. In particular, the pace of employment gains has been disappointing. Likewise, although the debt crisis in Greece appears to have cooled, the situation there (as well as in other similarly financially stressed nations) could quickly come to a boil again.

Going forward, expect downdrafts in the market to be a fact of life. Some will be harrowing, like the second quarter of 2010. Some will be relatively mild, like the garden variety 7-percent correction in the S&P 500 from this April 29 through June 15. Unfortunately, when you are in the midst of one of these downdrafts, there’s no way to know if it’s going to stop at “mild” or keep going to “harrowing” (or perhaps points beyond). What you can be certain of is that the intense media coverage will throw gasoline on the fire and raise investor anxiety even higher.  

Setbacks like the one we experienced from late April to mid-June are frustrating, and it might seem reasonable that the best course of action is to get out of the market until the wished-for clarity arrives and the environment seems less risky. But what might seem reasonable would be exactly the wrong thing to do because it confuses risk with the perception of risk.

For investors, the time to be nervous is when there’s nothing but blue skies on the horizon. The time to be opportunistic is when there’s blood running down the street and the high-paid talking heads are screaming that the sky is falling. It’s tough being a contrarian because these periods of great opportunity are obvious only in hindsight, but the market is a prospective, forward-looking mechanism and will start to turn up long before the storm clouds disappear.

Human nature is to be an indiscriminate buyer during periods of euphoria and a panicky seller during despair. This type of behavior is destructive to long-term performance, so the key to success is maintaining discipline when the headlines and talking heads are blaring.  

Today’s list of serious concerns is lengthy and ominous, but no more so than last year’s. Next year’s list might be totally different, but there will always be a list.•

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Kim can be reached at (812) 376-9444 or mickey@kirrmar.com.

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