Fading the News
Not all trades must be made in environments of pure fear. Chris Davis selectively makes contrarian investments in his Davis New York Venture Fund. “These often involve controversial situations where the market is discounting a company’s share price to reflect a perception of risk we think is greater than the probable economic risk to the business’s long-term fundamentals,” Davis says.30
Sometimes, his clients have trouble understanding the logic because the companies are often the subject of negative newspaper articles and broadcast media reports. “But it is precisely because so many other investors automatically sell companies with near-term challenges, however surmountable, that the potential for high returns exists in many such instances,” Davis adds.31
Consider Moody’s, a major credit ratings agency. The company was perceived to be at the center of the credit crisis, and it was the subject of many critical news stories. The company rated mortgage securities, many of which proved to be not nearly as safe as the ratings suggested. Yet, some investors thought that others were overreacting to the bad news and near constant stream of negative headlines—a phenomenon known as headline risk. But anyone who could look past media coverage could see that Moody’s business fundamentals were sound, and the company was financially healthy. Besides, Moody’s was one of the few firms anywhere in the world that offered credit rating and related services. As traders took advantage ...