Volatility and contrarianism

So volatility is back. The most interesting aspect of it is the extent to which it has affected my colleagues' temperaments. Where they were normally quite fundamental and balanced in their approach, now they have become very short termist and somewhat deterministic. I find it rather amusing actually. One fund manager I work with, and I actually have a lot of respect for, has now taken to storming around the office announcing the "R" word at every opportunity. "It is no longer a case of if but when and how bad". "What is the downside?". "How defensive is the stock?"

While I do not have a problem with doing macro, or having a macro view, I cannot help but think that the sudden change of view of my colleagues towards outright bearishness is little reactive and one-sided. There seems to be an assumption that the market is somehow mispriced. It is almost like there is a belief that the only way is down, as the shift out of cyclicals into defensives continues indefinitely. Yet I do not see any reason to make this assumption. Sure the macro outlook is not very good and no doubt there is a high chance that the US economy will experience some sort of recession this year (www.intrade.com recently put the odds at around 70%). But the market has already priced in at least a mild recession. So unless you believe it is going to be really bad, I do not see much reason to disagree with what the market is currently pricing.

The other issue is methodological. I recently had an interesting discussion with the aforementioned fund manager, one who is usually very contrarian, in which I challenged his macro view by suggesting that it wasn't contrarian enough. He responded by saying that one cannot be contrarian on the economy. Now this is where I disagree. For me the key issue in times such as these is to avoid the perils of deterministic thinking. To my mind, this fund manager has simply taken his view on the economy and applied a 100% probability to it. All he is really interested in is the downside that stocks have. There is no mention of the upside at all. But what happens if we don't have a recession? What happens if this another false positive? What happens under that 30% chance of a recovery and turnaround? I believe that the contrarian approach in the current market is to focus on both outcomes. Therefore I am trying to find stocks that have some defensive qualities but also have the ability to outperform in a recovery. Only then can one be sure to take on positive expected value trades.