Exchange-traded funds (ETFs) have made it possible for small investors to invest easily in asset classes (such as currencies and commodities) that were previously not readily accessible to them, or execute strategies (like short selling and hedging) that are markedly different from the typical “buy and hold” approach. This versatility makes ETFs especially suitable for the contrarian investor, who may seek to use a number of strategies and asset classes to initiate positions against prevailing trends.
A contrarian investor, in the simplest terms, is one who doesn't just believe that “the trend is your friend,” but takes this disdain for current investment trends a step further by actively initiating trading positions that are their polar opposite. Because experienced contrarians realize that current trends may not reverse quickly and could stay in place for months or years, they often make judicious use of stop-losses to cap their downside risk if their contrarian thesis proves incorrect. (For more, see Investing Like A Contrarian).
The most commonly cited example of a contrarian investor is one who is bearish when a market or asset class is in a bullish phase, or conversely, one who is bullish when the underlying trend is bearish. Such contrarian thinking does not extend merely to stocks, but also to every other conceivable asset class: bonds, currencies, commodities, real estate and so on.
To establish which ETFs could be used by a contrarian investor, we first need to establish the dominant investment themes that are currently prevalent. At present, equity market sentiment is unequivocally bullish, as stocks have staged a massive rebound from the steep losses incurred over the summer.
Although concerns about the growth pace of the world economy have manifested themselves at various points of this six and a half-year bull market, the latest indications are that global GDP will continue to expand at a moderate pace. In its World Economic Outlook update published in October 2015, the International Monetary Fund forecast that global economic growth would slow from a 3.4% pace in 2014 to 3.1% in 2015, before speeding up to a 3.6% rate in 2016. This moderate growth pace is expected to underpin low double-digit growth in corporate earnings for the MSCI World Index (a good proxy for the global economy) from 2015 to 2017.
4 Reasons To Invest In ETFs
Dominant Investment Themes
These are some of the dominant and unambiguous investment themes:
- U.S. equity benchmarks may be headed higher: U.S. indices set new records in 2015, with the S&P 500 index having more than tripled from its March 2009 low and the Nasdaq trading over the 5,000 level for the first time since the year 2000.
- Global equities may also be headed higher: Global markets have also staged a strong recovery over this bull run, with global market capitalization up more three-fold from the March 2009 low of $25.5 trillion to a record $73.3 trillion in June 2015. The correction of summer 2015 wiped out 19% of global market cap at its lowest point on September 29, 2015, but the robust rally in the fourth quarter has taken global market cap back up to about $65 trillion. Global equities could continue to trend higher, underpinned by an accelerating U.S. economy and stimulative monetary policy in many economic powerhouses including Europe, China and Japan.
- Euro could trend lower: European Central Bank (ECB) In October, President Mario Draghi's hinted that additional stimulus measures had led to an even weaker Euro. With the odds of a Federal Reserve rate hike at its December 2015, growing, divergence between the ECB and Fed's monetary policies could exacerbate downward pressure on the euro. Some currency experts forecast that the currency could be inexorably headed for parity with the greenback.
- Gold is also headed lower: Gold has historically displayed a significant negative correlation with the U.S. dollar. As the greenback reigns supreme in currency markets, bullion has retreated 15% from its 2015 high of over $1300 reached in January. Other factors that have contributed to gold's slide include few signs of inflation globally and bullion's diminished safe-haven appeal.
- Crude oil could continue to slide: Crude oil's 60% crash from a high of over $105 (WTI prices) in June 2014 to below $40 in August 2015 has been nothing short of stunning. Crude oil currently languishes in the mid-$40s thanks to a global supply glut from record U.S. shale oil production, continued high output from OPEC nations, and the return of Iran as a substantial oil exporter, even as global demand grows at an anemic pace.
- ETFs that benefit from a broad decline in U.S. equities: The contrarian investor who thinks U.S. equities may have topped out could consider initiating a short position in the SPDR S&P 500 ETF Trust (SPY). The contrarian would need to bear in mind that shorting the S&P 500 is a strategy that has worked only rarely over the past five years, such as during the volatile summers of 2011 and 2015. Another alternative to benefit from a broad decline in U.S. equities is to take a position in the ProShares Short S&P 500 ETF (SH), which seeks daily investment results that correspond to the inverse of the daily performance of the S&P 500. Contrarian investors who are particularly bearish on the U.S. technology sector after its record run in 2015 could consider initiating a short position in the PowerShares QQQ Trust Series 1 (QQQ), which tracks the performance of the Nasdaq-100. Alternately, a contrarian way to play U.S. technology through the short side is via the Short QQQ ProShares (PSQ), which seeks daily results that correspond to the inverse of the daily performance of the Nasdaq-100. To turbocharge one's short bets on U.S. technology, consider the ProShares UltraPro Short QQQ ETF (SQQQ), which seeks results equal to three times (or 300%) the inverse of the Nasdaq-100's daily performance. Or consider short positions in the venerable Dow Jones Industrial Average using ETFs like the ProShares Short Dow 30 (DOG) or ProShares UltraShort Dow 30 (DXD) (For more on the Dow, see: Strategies To Trade The Dow Jones Industrial Average.)
- An ETF to capitalize on a decline in global equities: The contrarian investor who is not optimistic about future prospects for global growth/equities despite the prevailing wisdom, could consider a short position in the iShares MSCI World ETF (URTH), which tracks the performance of the MSCI World Index.
- An ETF for trading the euro: Investors who wish to trade the euro without getting involved in the intricacies of forex contracts or currency futures should consider the Euro Currency Trust (FXE), which is an ETF that reflects the price of the euro. ETFs are admittedly not the most efficient way to trade currencies partly because of their expense ratios (0.40% for FXE) but are effective for trading smaller amounts. The contrarian investor who believes the euro may be oversold after its 22% tumble against the U.S. dollar since the beginning of 2014 and may, therefore, be poised to rebound could take a long position in the Euro Currency Trust.
- An ETF for betting on a rebound in gold: The SPDR Gold Shares ETF (GLD) is a cost-effective method for investing in gold, as its investment objective is to reflect the performance of the price of gold bullion less the ETF's expenses (expense ratio = 0.40%). Numerous investors subscribe to the view that gold could trend higher over time for a variety of reasons - an unexpected decline in the greenback, safe-haven buying from a geopolitical event such as war or terrorism, physical demand from India and China, a resurgence of long-term inflationary concerns, or all of the above. The GLD ETF, which has total assets of over $24 billion, could be an appropriate investment for betting on a rebound in gold.
- An ETF for wagering on higher crude oil prices: Whether oil prices will rebound or stay depressed for years is one of the most polarizing topics in the investment world today. While the reasons for oil's record slide are well documented, some compelling arguments can also be made for a rebound in oil prices above the $55-$60 mark. These include higher oil demand as the global economy expands, a return of the "risk premium" that has vanished from oil prices over the past year, lower shale oil production in the U.S. due to declining rig counts, and even an unexpected output cut by OPEC. A contrarian investor who subscribes to this view could consider the United States Oil Fund (USO), whose objective is to have changes in percentage terms of its units' net asset value reflect the price change in the WTI crude oil futures contract traded on the NYMEX.
The Bottom Line
It should be noted that these five ETFs are only meant to suggest possible ideas for the contrarian investor who is looking to trade against the dominant investment themes that are prevalent today. Note that contrarian trading can inflict massive losses if the entrenched trend continues. Before embarking on contrarian investing, therefore, we stress the importance of taking a number of precautions such as conducting adequate due diligence, consulting with your financial advisor, and using tight stops to cap trading losses.