Contrarian investors hope for better times in 2014

December 23, 2013 3:41 pm

Contrarian investors hope for better times in 2014

By Christopher Thompson

In the topsy-turvy world of contrarian investing, market rallies are generally a bad thing and volatility is good. Betting against the conventional wisdom yielded big gains for contrarians during the dotcom crash of 2000 and financial crisis in 2009. Not so the past 12 months.“Contrarian strategies have had one of the worst ever years,” says Beata Manthey, global equities strategist at Citi. “While simple contrarian strategies often perform very well at big macro turning points, they

Like the cool kid at school whose long hair and skinny jeans are copied by peers, contrarian trades of the past two years – such as going long on Europe – have gone mainstream.

At the same time big contrarian bets, like emerging market equities, which underperformed their developed world counterparts by 20 per cent according to the MSCI All Countries index, have fared poorly.

Part of the problem for frustrated contrarians is the sheer volume of easy money being pumped into the financial system by the world’s major central banks.

Tightening interest rate spreads have forced many investors to buy further down the credit hierarchy – and assume more risk – to achieve a decent yield. As a result, 2013 was a bumper year for junk bonds – which returned an average of 8.8 per cent according to the iBoxx corporate bond index – and subordinated bank debt.

So what is a volatility-starved contrarian to do in the new year?

One potential opportunity is commodities, traditionally fertile contrarian terrain.

The MSCI Commodity Producers Index underperformed the World Index by more than 15 percentage points this year as miners were plagued by cost overruns and subdued commodity prices.

Evy Hambro, head of BlackRock’s natural resources equities team, says the market could have seen the bottom, with more miners taking steps to improve cost discipline after seeing their shares shunned by investors.

“Our checklist is definitely moving from the red zone into amber and there are a few green lights in there as well – that’s what we’re looking for as we go into 2014,” he says.

Another possibility – with the eurozone out of recession and US tapering having begun – lies within the broadly optimistic economic consensus for 2014.

Adrian Docherty, head of banking advisory at BNP Paribas, says longer-term risks of a new banking crisis, brought about by growing levels of loan forbearance and rising interest rates, could materialise sooner than some expect.

“2014 could be like 2004,” says Mr Docherty. “We think everything is fine, confidence is higher than merited and therefore asset bubbles continue to develop . . . these are long-term risks but there is a chance they could materialise during the year.”

Prevailing market tranquillity could also be knocked out of sync by two big “known unknowns”, to borrow the terminology coined by Donald Rumsfeld, the former US defence secretary. These are the end of quantitative easing and the eurozone crisis.

“The fact that we have so much excess liquidity keeps the market calm,” says Armin Peter, head of European debt syndicate at UBS. “If central banks were to walk away from that there will be a lot more volatility.”

In Europe, 2013 could be remembered as the year when existential fears of a euro break-up finally subsided in the wake of Mario Draghi’s promise to do “whatever it takes” to save the single-currency union.

Since then foreign, especially American and Asian, investors have rushed back into euro-denominated assets and increased their lending to banks in core countries.

But flighty investors could pack their bags once more, like they did in 2011, if the European Central Bank’s review of banks’ balance sheets and subsequent stress tests rattles investor confidence.

In addition, fractious local politics, particularly in Spain, Greece, Italy and Portugal, could provide contrarian openings for short trades.

”There are a number of possible adverse political events that themselves may represent profitable short trades in Europe,” says Saul Greenberg, co-founder of SCIO Capital, a Europe-based asset manager. “Consider trades around Catalonia’s desire for independence from Spain and the significant market upheaval that would result if they were to declare independence, such as shorting Catalan banks.”

‪Nevertheless Alberto Gallo, head of European macro credit research at Royal Bank of Scotland, argues next year is the recession-battered periphery’s turn to shine.

Mr Gallo says investors should concentrate their bets on assets with exposure to recoveries in Italy, Spain and Portugal. German debt investors, by contrast will lose out as the gap between the core and periphery yields increasingly narrows.

“Long sangria and panettone vs sauerkraut,” he says.

A true contrarian might conclude the opposite.