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Contrarianism for fun and potential profit

Many market experts were bullish on equities at the beginning of 2014, and not without reason. 

Trader examines data
Source: Bloomberg

We remain in a low interest rate environment, bond purchases by the Federal Reserve have only recently come to an end, and the expectation that the European Central Bank will continue its loose monetary policy has helped to buoy risk assets.

Quantitative easing speculation has also helped to drive down sovereign debt interest rates, so the case for there being little alternative for yield seekers apart from equities has been strengthened to an extent.

With a large part of the FTSE 100 being made up of companies such as BHP Billiton, Rio Tinto and Glencore, the large exposure to the mining sector – which currently accounts for 8.15% of the FTSE 100 weight, the long-running bear market in commodities, which is yet to show any signs of bottoming – has tended to weigh on the index in recent years.

Slowing Chinese demand for commodities on the back of an economy that continues to struggle to turn to a consumer-led market from that of a heavily publically invested one could lead to a slowdown in commodities demand globally. If we were to assume that the bear market in commodities continues throughout the first quarter of 2015, we could expect that it would continue to negatively impact emerging market economies. Given that FTSE 100 companies derive almost 33% of profits from the EM, this would not bode well.

Looking at the broader index,  the FTSE 350 becomes rather enlightening. Many would admit that the FTSE 250 is a better reflection of the UK economy than that of the FTSE 100 for all the reasons given above, and the weighting towards commodities is usually not as pronounced. 

FTSE 350 annual performance chart

The past eight years have provided a mixed bag in terms of overall performance, but to be fair we’ve undergone some significant swings in all indices as a result of the financial crisis. It may be too early to say that the storm has completely abated, but the past two years have been broadly positive for the FTSE 350.

Table 1

Thus, what goes down must go up, or so the saying goes. As we look into 2015, one strategy that could have some appeal for the more contrarian-minded would be to take a look at the ten worst performers of the FTSE 350 over the past year. Since 2005, a strategy of buying the ten ‘dogs of the FTSE 350’ at the beginning of the year and holding them for the first quarter has returned an average of 11.4%, versus an average Q1 return from the broader index of just 0.75%.

Table 2

The strategy has in fact outperformed the index eight times in the period 2005-2014, with only 2007 and 2013 seeing returns below that of the benchmark index. Clearly this strategy is not for the faint-hearted – it requires going against the herd and the usual risk management caveats apply. But history teaches us that optimism abounds at the beginning of a year, and even the previous year’s worst performers are not immune from the general outbreak of positive feeling in January. 

FTSE 350 % return/Q1 strategy chart

If 2014 is remembered for anything, it will be the massive declines in the raw material sector, but in particular the rout in oil prices.

The 40% decline in oil prices since June has taken its toll, and few would have predicted the rout seen as a result of supply gluts, a stronger US dollar and indeed an overall lack of global demand.

Thus, it’s not surprising that, as we head towards the end of the year, the worst performers include oil stocks (Tullow, Afren), miners (Ferrexpo, Lonmin) and, of course, Tesco, which definitely serves to underpin the bravery needed. The year has not been kind to these stocks, and the situation could get worse. A look back at previous years suggests that such a strategy can yield excellent results, however.

Clearly it’s too early to say definitively which ten stocks are the worst performers at this juncture, with almost two weeks to go until year end. The dramatic volatility and resultant equity declines over the past week or so have, in themselves, provided short term opportunity for bargain hunters and technical traders.

This may be the beginning of the much heralded Santa Rally for the broader equity market, but most investors will be looking to Q1 for investment opportunities, even of the short term variety.

FTSE 350 worst performers at time of writing (19 December) are as follows:

2014

Bear in mind that in 2013, the price of gold fell 30% and silver fell by 40%, and the following stocks were the worst performing that year:

2013

They are all mining stocks for the most part, yet the bounce in precious metals in the first quarter of 2014 saw this basket of stocks outperform the FTSE 350 by a significant margin – a gain of 6.64% against a decline of 1.57% in the broader index.

UK retailer Debenhams was another one on the worst performer list in 2013, falling some 39% over the course of the year and rebounding by almost 16% in the first part of 2014.

Does this mean that Tesco, currently off its recent lows, but off by a substantial 46% year to date is in for a rally in Q1?

Fortune may favour the brave with respect to the worst performing equities this year, but if there is an increase in demand for oil – coupled with some production cuts from OPEC, along with some investor bargain hunting – we may well see the strategy work again for Q1 2015.

Denne informasjonen er utarbeidet av IG, forretningsnavnet til IG Markets Limited. I tillegg til disclaimeren nedenfor, inneholder ikke denne siden oversikt over kurser, eller tilbud om, eller oppfordring til, en transaksjon i noe finansielt instrument. IG påtar seg intet ansvar for handlinger basert på disse kommentarene og for eventuelle konsekvenser som et resultat av dette. Ingen garanti gis for nøyaktigheten eller fullstendigheten av denne informasjonen. Personer som handler ut i fra denne informasjonen gjør det på egen risiko. Forskning gitt her tar ikke hensyn til spesifikke investeringsmål, finansiell situasjon og behov som angår den enkelte person som mottar dette. Denne informasjonen er ikke utarbeidet i samsvar med regelverket for investeringsanalyser, så derfor er denne informasjonen ansett å være markedsføringsmateriale. Selv om vi ikke er hindret i å handle i forkant av våre anbefalinger, ønsker vi ikke å dra nytte av dem før de blir levert til våre kunder. Se fullstendig disclaimer og kvartalsvis oppsummering.

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Denne informasjonen er utarbeidet av IG, forretningsnavnet til IG Markets Limited. I tillegg til disclaimeren nedenfor, inneholder ikke denne siden oversikt over kurser, eller tilbud om, eller oppfordring til, en transaksjon i noe finansielt instrument. IG påtar seg intet ansvar for handlinger basert på disse kommentarene og for eventuelle konsekvenser som et resultat av dette. Ingen garanti gis for nøyaktigheten eller fullstendigheten av denne informasjonen. Personer som handler ut i fra denne informasjonen gjør det på egen risiko. Forskning gitt her tar ikke hensyn til spesifikke investeringsmål, finansiell situasjon og behov som angår den enkelte person som mottar dette. Det er ikke utarbeidet i samsvar med lovens krav for å fremme uavhengighet av investeringsanalyse og som sådan er ansett av å være markedsføringskommunikasjon. Selv om vi ikke er hindret i å handle i forkant av våre anbefalinger, ønsker vi ikke å dra nytte av dem før de blir levert til våre kunder.