By Elizabeth Blessing on March 13, 2022Reading Time: 4 minutes
The inflation problem of 2022 is more complicated than just the specter of continuing escalating prices. The real challenge is how to invest in a high inflationary environment. This leaves many investors wondering if now is the time to employ some strategic inflation hedges to protect their wealth.
What is contrarian investing?
Will you go against the grain?
Why popularity does not work
In the U.S., inflation rates have hit 40-year highs. Many of the factors that have contributed to soaring prices are related to the global pandemic. These include supply chain disruptions and the excessive growth in the money supply. This is due to the trillions of dollars the government pumped into the economy.
Added to this is the war in Ukraine, which is expected to increase the inflation problem as oil prices skyrocket. For many, it’s not enough to employ hedges to offset the decline in their purchasing power. They are looking for profit opportunities that others might be missing.
In times like these, they see the benefits of contrarian investing. These strategies have long been used by some of the world’s most successful investors. They seek out hidden gems in the market. We’re talking about the likes of Warren Buffett, Charlie Munger, Sir John Templeton, and Michael Burry.
One of the most widely reported contrarian success stories was Michael Burry’s famous shorting of the housing market prior to the financial meltdown of 2007-2008. Burry was the founder of hedge fund Scion Capital. He started taking short positions in subprime-mortgage bonds years before the housing bubble burst. At the time, real estate profits were booming, and many scoffed at his strategy.
However, Burry’s research proved accurate. The housing market crashed and his contrarian bets were wildly successful. His hedge fund made investors over $700 million and netted him a profit of $100 million. Between November 1, 2000, and June 30, 2008, Scion Capital had a net gain of 489%. Over that same time, the S&P 500 returned approximately 2%.
Burry’s story (documented in The Big Short) demonstrates some key elements of contrarian investing:
Each year various investment firms come out with their predictions for the top contrarian investments for the next twelve months. Here we review three strategies that might seem counter-intuitive. These could hold some surprising profits for investors willing to go against the investing herd.
In their contrarian report for 2021, analysts for U.S. investment bank Citi were bullish on the energy sector. They selected oil companies Exxon Mobil and BP plc as top picks. Their predictions worked out as Exxon and BP posted gains of approximately 48% and 30%, respectively, for the year.
In their 2022 report, however, Citi contrarians are pulling back on the energy sector in favor of utilities. They expect an economic slowdown in 2022, which would benefit global utilities and consumer staples over energy.
If inflation increases and the economy worsens, consumers will prioritize getting back to the basics. This will mean spending on life’s essentials (food, shelter, and utilities). For this reason, Citi contrarians also recommend shorting the European luxury goods sector. They state will face headwinds as consumers reduce spending on high-priced goods.
For almost 30 years, Morningstar has published its annual “Buy the Unloved” report. The financial services and investment research firm reviews downtrodden fund groups for contrarian plays. The company also publishes statistics comparing trailing returns for “unloved” (out-of-favor funds) versus “loved” (in-favor funds).
It appears there is profit to be made in buying funds that others view with disdain. Over the past 10 years, the Morningstar’s unloved fund group had trailing returns of 13.6% compared to 8.3% for the loved group. The one-year trailing returns were more dramatic. The unloved group posting a 24% return versus the loved group’s 6.9% return.
Now Morningstar is quick to point out that shopping for bargains in the unloved group should not be an investor’s core strategy. Investors should use a disciplined and long-term way as part of a diversified stock portfolio.
Morningstar creates two versions of unloved funds. Version 1 focuses on the most out-of-favor funds with the most absolute outflows. Version 2 considers more categories, including bonds.
In 2022, for version 1, Morningstar’s unloved categories are large growth, mid-growth, and world large-stock value. For version 2, the most unloved categories are Latin America stock, energy, and world large-stock value. For each category, Morningstar includes investment ideas, which you can find in their annual report.
The recent narrative among some analysts is that beaten-down Chinese stocks are poised for a huge rebound. However, timing is an issue, and some contrarians say that it’s too early to start a buying spree.
Patrik Schowitz of JPMorgan Asset Management says their biggest contrarian bet is to not rush into emerging markets. This also means China. The outlook for the Chinese economy is murky. In particular, the country continues to recover from pandemic shutdowns. Also, the possibility of more Chinese government regulation is a worry. This provides a challenge on determining which stocks are good investments.
While the consensus call is to invest in emerging markets, Schowitz says Japan represents a better investment opportunity. Says Schowitz, “We like Japan. I do not think many people like Japan. We think it looks cheap.”
A contrarian strategy that produces gains that outpace the rise in consumer prices could be an answer to the inflation problem. However, being a contrarian is not without drawbacks. It is an approach that has its risks and can take many years to pay off. It requires a degree of patience and a good amount of research to find the best opportunities. Strategists who wrote Citi’s 2022 contrarian report remind investors that being contrarian “only delivered in 9 out of the last 26 years.”
Because of this, some investors might opt for more traditional inflation hedges as a response to an inflation problem. Examples include gold, silver, real estate, stocks, and commodities. And for those interested in a nontraditional choice, there’s a hedge for you as well. According to investment banker JPMorgan, some institutional investors are looking at Bitcoin for inflation protection!