When Contrarianism Works

I recently came across a paper by Cremers, Pareek and Sautner on Stock Duration, Analyst Recommendations, and Overvaluation.  In this paper they look at how stock duration, the holding period of institutional investors, interacts with analyst recommendations.

One of many interesting findings was a twist on the classic finding of stock underperformance or outperformance driving the analyst rating, rather than vice versa:

But interestingly enough, when stock analysts are late to the party of a stock with long term holders, the stocks still tend to do well.

However, when fast money is holding the stock then an analyst's extreme buy recommendation has on average marked the peak of the stock’s outperformance. The return of fading these optimistic short term investors were found to be larger if positions are not entered for at least 3 months after the signal.

On the downside, extremely bearish analysts are often too pessimistic, but the effect is larger when there is a lot of fast money involved. 

So while investors have many reasons to value contrarianism, it’s important to note that fighting against long term bulls does not necessarily result in a favorable outcome. It’s better to be bullish in the face of pessimists. But if you must be bearish make sure that the people on the other side of the trade are the types who are trying to make a quick buck.