Contrarian view: Which sectors are comeback candidates?

Over the past 10 years, through April 2014, equity energy stocks led all major Morningstar fund categories with annualized returns of 11.1%, while all domestic equity funds returned an annualized 7.9% on average. Is it time to trim allocations to energy stocks? Contrarians might favor moving money into 10-year laggards like precious metals (annualized returns of 5% for this fund category), financials (3.1%), or Japanese stocks (1.9%).

Then again, they might not. “I'm not sure that I would agree with the concept of buying Japanese shares,” says Steven Jon Kaplan of Contrarian Advisors, a wealth management firm based in Beverly Hills and New York. “I also favor energy shares; recent strength should not be a negative factor as long as much greater gains likely lie ahead.”

Why this seemingly contrary contrarian view? A 10-year period might be too long a time frame for this sort of analysis, contends Kaplan, who also is the founder of the blog TrueContrarian.com. “When an asset class has experienced a crushing two- or three-year bear market and has recently begun to recover,” he says, “that category of assets generally consists of securities where almost everyone who was uncommitted has been flushed out, paving the way for what could become a powerful rebound.”

Thus, a two- or three-year look-back may spotlight potential contrarian choices. “It’s a result of human nature,” Kaplan says. “When investments start to go down, people are reluctant to sell right away. After two or three years, though, they really give up. So they sell and prices go down. Then institutional money might come in, buying what’s cheap.” Once the price moves up a bit, tactical investors and momentum players may see a trend and spark a recovery.

If that’s the ideal scenario, Japan doesn’t fit the model of a “true buying opportunity,” according to Kaplan. “It has been a long-term disaster,” he says, “dating back many years. Nothing has happened recently to flush out investors.” Financials, which have performed reasonably well in the past three years, also don’t meet Kaplan’s criteria.

Conversely, precious metals funds, which largely hold gold mining stocks, might be the poster children for Kaplan’s approach. After losing 49% in 2013 (trailing the S&P 500 by more than 80 percentage points), this Morningstar category was showing annualized losses of over 28% for the last three years. “This year,” Kaplan points out, “it’s been the best performer.” Morningstar shows precious metals funds up nearly 15% in the first four months of 2014, tops on its year-to-date list.
Kaplan thinks the recovery in gold and silver mining stocks can continue. For example, he’s upbeat on Market Vectors Junior Gold Miners ETF (GDXJ). Other current favorites include materials companies like copper miners as well as agricultural stocks.

Kaplan also likes some energy sectors. “Crude oil has had a good run,” he says, “but I think there are opportunities in other energy companies, such as coal and uranium miners.”

Five years into a bull market, Kaplan has become cautious. “General U.S. equity indices have likely terminated their uptrend,” he wrote in his blog at the end of April. It may be time for advisors to go to ground, digging deeply for future outperformers.

Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.

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