27 Contrarian Investment Ideas for 2015 and Beyond By Morningstar Investment Research
Stock, fund, and ETF ideas for investors who are putting new money to work and don't mind some short-term volatility along the way.
It's no wonder that Wayne Gretzky's comment about skating where the puck is going to go--rather than where it has been--has been repeated so often. Of course, history can be instructive. But whether you're playing sports, managing a business, or raising a teenager, anticipating what's next will usually hold you in good stead.
The same can be said of managing your investments. If you're rebalancing your portfolio or initiating new positions--funding your IRA, for example--it's wise to do so with a contrarian mindset. Last year's winners will rarely make for a good shopping list because their valuations are often inflated. Instead, when deploying new assets, you're usually better off looking to parts of the market that have underperformed and may be due to recover.
Of course, beaten-down pockets of the market may be cheap for good reason, and that should be of particular concern for contrarian types today. As investors have been in "bring on the risk" mode for five-plus years, you can bet that they'd be pouncing if easy opportunities were hiding in plain sight. Most of today's beaten-down market pockets are in the dumps because of some combination of falling energy prices, concerns about global economic malaise, and too-low inflation--intertwined issues that won't resolve themselves overnight.
Thus, investors aiming to capitalize on the market's downtrodden pockets today should make sure they fully understand the fundamentals (including the bear case) of any prospective investment, have an appropriately long time horizon to capitalize on a potential recovery, and keep more speculative positions to a small part of their portfolios. Alternatively, investors who would rather not buy individual stocks or sector-specific ETFs might consider delegating the contrarian decision-making to a good value-oriented stock-picker who can conduct due diligence on their behalf.
What follows is a review of some parts of the market that could be poised for recovery owing to poor performance, investor redemptions, and cheap valuations--or some combination of all three. Within each area, I've highlighted some individual stocks, exchange-traded funds, and actively managed offerings for your consideration.
The Thesis: Asset-allocation guru Bill Bernstein piqued my interest in gold-mining equities this past fall, when he enthused about them at the annual Bogleheads Conference. Not only does he consider these securities to be among the best diversifiers for portfolios consisting of stocks and bonds, but he also thinks the timing is right, as gold-mining stocks are in the dumps. (That stands in contrast to his stance in 2011, when Bernstein presciently said that the asset class was overvalued.)
Kristoffer Inton, who covers gold miners for Morningstar, agrees that the stocks look cheap right now; the typical gold miner in Morningstar's coverage universe is trading at a 20% discount to fair value. Inton points out, however, that most miners have historically made poor capital-allocation choices; the stocks will also be buffeted around by gold-price fluctuations. Thus, investors considering an investment in mining stocks should limit it to a small slice of their portfolios and have a long time horizon.
For the Stock-Picker: Both Barrick Gold (NYSE:ABX) and Yamana Gold (NYSE:AUY) rate 5 stars as of mid-January 2015. Barrick, the world's largest gold miner, boasts costs that are well below the industry average, and Inton likes that management has taken steps to optimize its portfolio. Yamana, too, has lower operating costs than many other miners, and Inton believes that its development pipeline is better than many other producers'.
For the Indexer: Two exchange-traded funds--iShares MSCI Global Gold Miners (NYSEARCA:RING) and Market Vectors Gold Miners (NYSEARCA:GDX) --provide broad exposure to gold-mining stocks. The iShares fund is cheaper than the Market Vectors offering, but it's also more concentrated in its top holdings.
For the Active-Management Aficionado: Oppenheimer Gold & Special Minerals (MUTF:OPGSX) is Morningstar's top pick among actively managed precious-metals equity funds, featuring long-tenured management and a focus on higher-quality producers. However, the fund won't necessarily be a pure play on gold-mining stocks.
The Thesis: With oil prices falling through the floor, energy stocks have gotten cheap in a hurry. In the near term, senior analyst Jason Stevens expects excess oil supply to weigh on oil prices--and, in turn, energy-stock prices. But he thinks oil prices will recover once supply/demand imbalances correct themselves. One major caveat, in addition to the difficulty in predicting energy prices: Many diversified portfolios may well include ample exposure to energy stocks already. For example, the S&P 500 currently has 8% in the energy sector.
For the Stock-Picker: A broad swath of industries under the energy umbrella are currently trading at sizable discounts to Morningstar analysts' estimates of fair values, according to Morningstar's Market Fair Value graph. (Click on "Industry" in the left-hand navigation bar to see price/fair values by industry.) Among Stevens' top picks in the sector, outlined here, are Whiting Petroleum (NYSE:WLL), BP (NYSE:BP), and Santos LTD (STO). All rate 5 stars and carry narrow moat ratings, though they also carry fair value uncertainty ratings of medium or higher. That reflects the difficulty of determining what the companies should be worth, given the wild card of fluctuating energy prices.
For the Indexer: Both Vanguard Energy ETF (NYSEARCA:VDE) and Energy Select SPDR (NYSEARCA:XLE) offer well-diversified exposure to the energy sector at a very low cost. However, it's also worth noting that both are heavily concentrated in their top positions. Both have roughly a third of their assets in ExxonMobil (NYSE:XOM) and Chevron (NYSE:CVX), for example. (The stocks both carry 4-star ratings as of mid-January 2015.)
For the Active-Management Aficionado: Morningstar's favorite actively managed energy-sector fund has long been Vanguard Energy (MUTF:VGENX). Among actively managed funds with Analyst Ratings of Silver or better and at least double the S&P 500's weighting in the energy sector, several fine value-leaning funds fit the bill. They include large-value fund Artisan Value (MUTF:ARTLX), large-blend offering Longleaf Partners (MUTF:LLPFX), and world-stock fund Tweedy, Browne Value (MUTF:TWEBX).
In a related vein, high-yield bonds have been hit hard during the energy slump, in part because much of the issuance is in the energy sector. Thus, opportunistic investors might also consider plumping up their positions. In this video, director of fund research Russ Kinnel suggests Fidelity High Income (MUTF:SPHIX) as a way to capitalize on a resurgence in the high-yield market.
Treasury Inflation-Protected Securities The Thesis: With global economic weakness a concern and inflation ultralow, it's no wonder that all manner of securities thought to insulate against higher prices have been in the dumps. Case in point: Funds focused on Treasury Inflation-Protected Securities are the only fixed-income category to post a loss over the past three years.
Of course, there's no readily apparent catalyst for higher prices--and in turn, demand for inflation hedges. The U.S. economy is performing well, but wage growth has been sluggish. Europe remains in the dumps, and growth in major emerging markets is also slow relative to historical norms. But by jettisoning inflation hedges, investors seem to be saying that they believe inflation will stay way down for the foreseeable future, and that may not be the case. The so-called break-even rate on a 10-year TIPS bond was about 1.6% as of mid-January 2015. That means that if inflation runs hotter than that level--and it historically has--the TIPS bondholder will be the winner versus the buyer of a nominal (non-inflation-protected) Treasury bond. (Jason Zweig made a persuasive case for giving TIPS a look in The Wall Street Journal last weekend.)
For the Bond-Picker: Individual investors can purchase Series I Savings Bonds, Treasury bonds whose interest rates are adjusted to keep pace with inflation, directly from the Treasury at treasurydirect.gov. (This entry on Bogleheads.org includes an excellent comparison of I-Bonds versus TIPS.) The big drawback with I-Bonds is that purchases are limited to $10,000 per calendar year, though taxpayers can purchase an additional $5,000 in I-Bonds with their tax refunds.
For the Indexer: Schwab US TIPS ETF (NYSEARCA:SCHP) is currently the cheapest ETF that focuses on TIPS, with an expense ratio of just 0.07%. However, it's worth noting that core TIPS funds like this one tend to have long durations (7.74 years, in the case of the Schwab fund), which means they could perform poorly in a rising-interest-rate environment. Vanguard Short-Term Inflation-Protected Securities Index (available as both an ETF (NASDAQ:VTIP) and an index fund (MUTF:VTIPX)) has low costs of 0.10% (for the ETF) and a much shorter duration of 2.4 years.
For the Active-Management Aficionado: Vanguard Inflation-Protected Securities (MUTF:VIPSX), Morningstar's sole Gold-rated actively managed TIPS fund, features ultralow costs and a no-nonsense strategy. American Century Inflation-Adjusted Bond (MUTF:ACITX) is Bronze-rated but features a shorter duration.
The Thesis: Commodities-tracking investments have fared much worse than TIPS over the past few years, owing to global economic weakness, sagging energy prices, and slack demand for all manner of commodities, especially in emerging markets. Broad-basket commodities funds, which many investors use to ward against inflation, have dropped nearly 20% over the past three years.
Of course, it's close to impossible to predict the "right" price for commodities; that's one reason that asset-allocation specialists like Rick Ferri believe they aren't a great addition to investors' tool kits. But for investors wishing to add a long-term strategic hedge against unexpected inflation to their portfolios, and perhaps do so at the right price, a small slice in a commodities-tracking investment could make sense. Morningstar Ibbotson's research recommends commodities allocation in the neighborhood of 4% to 6% of the total portfolio.
For the Stock-Picker: Investors who wish to play falling commodities prices by owning the stocks of commodities suppliers should be aware that those firms' share prices will depend on company-specific factors as well as gains or losses in the value of the commodities they produce. I outlined some picks in the mining and energy sectors above, and investors might also consider the basic-materials sector more broadly. This article outlines some additional ideas within the sector, where the typical company in Morningstar's coverage universe is trading below our analysts' estimate of its fair value.
For the Indexer: Greenhaven Continuous Commodity ETF (NYSEARCA:GCC) is a favorite among Morningstar's researchers of passively managed products. In contrast with most other broad-basket commodities-tracking ETFs, it equally weights various commodities, resulting in a much lower allocation to energy stocks than its peers. (Of course, that may not be desirable for energy bulls.)
For the Active-Management Aficionado: Credit Suisse Commodity Return Strategy (MUTF:CRSOX) is Morningstar's sole actively managed Medalist fund in the commodities broad-basket category, featuring a Bronze rating. And it uses a passive strategy as its backbone, buying derivatives to obtain exposure to the Dow Jones UBS Commodity Index and investing the collateral in ultrashort government-backed bonds.
The Thesis: Although investors continued to shovel dollars into foreign-stock funds last year, their loyalty wasn't rewarded. With the exception of a few strong pockets, especially India, foreign stocks dramatically underperformed U.S in 2014. Here again, the stocks haven't slumped for nothing: Europe remains mired in a funk, and growth in emerging markets has slowed considerably, too.
Those situations won't be remedied overnight, but investors who are in rebalancing mode might consider steering some dollars to foreign stocks and funds. More than a third of the foreign stocks in Morningstar's coverage universe currently rate 4 or more stars, whereas just 18% of U.S. stocks do. Morningstar's quantitative ratings for individual equities also point to foreign stocks, especially emerging markets, looking relatively inexpensive right now, as discussed in this article.
For the Stock-Picker: To help home on on high-quality, undervalued foreign stocks, I screened for wide-moat firms with low uncertainty ratings and at least 4 stars that happen to be domiciled overseas. The screen turned up a complement of energy companies, including Schlumberger (NYSE:SLB) and Enbridge (NYSE:ENB), but it also included firms in the health-care and consumer-defensive sectors, which won't depend on an economic recovery to improve their profitability. Morningstar.com Premium Members can click here to view the complete output.
For the Indexer: Vanguard FTSE All-World ex-US is a fine core foreign-stock choice, featuring a low expense ratio of just 0.15% and ample emerging-markets exposure (20% of assets). It's available as an ETF (NYSEARCA:VEU) or traditional index fund (MUTF:VFWIX). Alternatively, an investor could lower his or her aggregate expenses by employing separate funds for developed- and developing-markets exposure. In my ETF Saver portfolios, for example, I employed Vanguard FTSE Developed Markets ETF (NYSEARCA:VEA) and Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO). This strategy has the benefit of lowering costs (the developed-markets fund charges just 0.09% per year, versus 0.15% for emerging) while also facilitating easy rebalancing between developed and emerging markets.
For the Active-Management Aficionado: Investors looking to capitalize on depressed valuations overseas should consider allocating to a value-leaning foreign-stock fund. While Morningstar favorites Oakmark International (MUTF:OAKIX), Dodge & Cox International Stock (MUTF:DODFX), and Artisan International Value (MUTF:ARTKX) are closed or have taken steps to limit new inflows, Harbor International (MUTF:HAINX) is a solid foreign-stock fund that's accepting new investor dollars. For investors seeking a play on emerging markets, American Funds New World (MUTF:NEWFX) and T. Rowe Price Emerging Markets Stock (MUTF:PRMSX) are both fine choices.
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