Contrarian investing is widely used by traders and investors who believe that, by going against the crowd, this approach will allow them to effectively “time” the market at key turning points.
This view has certainly proven its value in identifying major stock market lows in recent years; however, it no longer appears to be very effective in identifying major tops. (But stay tuned, as I’ll explain why contrarianism can still work in your favor—if you apply it properly.)
Indeed, taking a contrarian approach to the market in the last several months of last year, and into 2026, has so far proven to be a failed strategy. Various institutional and retail investor sentiment surveys showed elevated levels of bullishness at several junctures of 2025—all to no avail—as the S&P 500 shrugged off the excess enthusiasm and continued its march to new highs in the last several months of last year.
To take just one example, in late 2025, bullish readings from several major sentiment indicators—including the widely watched AAII survey—often rose above the historical average of around 38% between October and December. At times, it even climbed into the mid-40s, which is considered to be “too bullish” by many contrarian investors.
What’s more, a Q4 Trader Sentiment Survey by brokerage firm Charles Schwab found that, as of late October, 57% of traders described themselves as bullish on the market, matching Q3’s number, which was the highest level of optimism recorded since the survey was established in 2022. And yet, the market continued to trend mostly higher despite the persistence of bullish sentiment.
Underscoring this point, recent AAII surveys have shown the highest bullish sentiment levels in over a year (at around 50%), even as several major indexes led by the Russell 2000 Small Cap have rallied to new highs.
[text_ad]
One reason why using “excess” bullish sentiment to identify market tops so often fails individual traders is that bull markets tend to be momentum-driven, and strong forward momentum can take time—often several months—to completely dissipate. Plus, as the market is historically inclined with an upward bias (indeed, as someone has famously said, “Stocks were created to go up, not down”), sometimes it simply ignores even the most entrenched collective enthusiasm among investors for whatever reason.
Another explanation as to why the contrarian principle isn’t always reliable in identifying market tops is the liquidity factor. Bull markets thrive on liquidity, and as long as it’s ample, equities often ignore even the most persistent crowd optimism and continue climbing. And as it now stands, with a much more accommodating Fed in 2026 now that quantitative tightening (QT) has ended and monthly asset purchases have resumed, it’s possible the stock market will continue to ignore the recent excess of bullish sentiment in the coming months.
By contrast, the contrarian principle tends to be most reliable in flashing signals for major market lows following a big decline. To show just one instance, last year’s Q1 spike in bearish consumer sentiment (see chart below) immediately preceded the major low in the S&P in early April, underscoring this important point.
Source: Yardeni Research
More importantly, for individual investors with a longer-term time frame, a contrarian approach can work in your favor if you apply it to sector rotation. That is, if you look for specific S&P sectors, industry groups and sub-groups, you can often locate attractive opportunities that are being overlooked by the crowd. This is one way to leverage the tendency for the contrarian principle to consistently identify bottoms, rather than tops, in the stock market.
An example of this principle in action was last year’s tendency for investors to maintain a bearish posture on the healthcare sector. As I noted last summer in the Cabot Turnaround Letter, the multi-month decline in the S&P healthcare sector—as reflected in various sector ETFs—was likely to rebound in the final months of 2025 and into 2026 based on not only historical tendencies, but also contrarian sentiment. And that’s exactly what has happened to date, as healthcare stocks have largely experienced a strong rebound since bottoming last August.
I also emphasized in the newsletter all through the second half of 2025 that consumer staple stocks would likely outperform in late 2025 and into 2026, even as bearish sentiment prevailed in this sector for much of last year. True to form, the contrarian principle came to the rescue starting in November, with the leading consumer staples stocks bottoming in November-December and launching a powerful rally in the early part of 2026 to date.
To that end, embracing a contrarian approach to individual stocks is a key part of not only value investing generally, but of turnaround-focused investing particularly. It has certainly proven its worth for identifying the stocks and industry groups most likely to experience a turnaround after a period of prolonged decline, and it’s a tool we consistently use to good effect in the Cabot Turnaround Letter.
If you’re interested in adding a dose of contrarian investing to your strategy, I suggest using it for identifying market bottoms rather than tops for maximum reliability. Better yet, consider subscribing to the Cabot Turnaround Letter to learn more about how this principle can be helpful to your bottom line.
[author_ad]
