What Is a Contra Market?
Contra market is a description of an asset or investment that moves against the trend of the broad market. Contra market securities and sectors tend to have a negative correlation, or weak correlation, with the broader market index and the general economy. When the economy is weak or stock market indexes underperform, contra segments outperform, and vice versa.
Understanding a Contra Market
A contra market stock or sector is one that performs well in bear markets and underperforms in bull markets. For example, defensive stocks—so called because of their relative immunity to economic cycles—such as large pharmaceuticals and utilities, may outperform (but not necessarily rise in value) during bear markets because of their stable revenues and cash flows. However, they may not fare as well during bull markets when investors favor riskier stocks and sectors such as technology and basic materials.
"Safe haven" securities such as U.S. Treasuries and gold, which have the greatest appeal during economic turmoil, are also classic examples of contra market plays.
- A contra market is one that moves against the trend of the broader market and tends to have a negative correlation with it, or at least a relatively weak correlation.
- Investors utilize contra markets to hedge, make contrarian investment plays, or to diversify holdings.
- The advantage of contra markets is that they tend to be out favor when the broader market is doing well, which may provide some opportunities for value investors to snatch up some deals.
- The disadvantage of contra markets is that investing in them during a broad market rally could mean missing out on big returns from the broader market.
Contra Market Strategies
Contra market strategies are employed for a variety of reasons. Possibly an investor believes the broader market will decline, and so they wish to gain some protection, or possibly profit, by moving some or all of their funds into contra markets. Or possibly the investor is a contrarian, meaning they prefer to buy or sell assets that go against the flow of the broader market or economy. The investor may also simply want to diversify and not hold only assets that tend to move in the same direction.
- Hedging: Investors can use simple contra market strategies to hedge their portfolios. For example, if an investor’s portfolio has significant exposure to equities, they could purchase an asset class that is typically viewed as a safe haven, such as gold, to protect against a severe stock market downturn. Investors can purchase physical gold from government mints, precious metal dealers and jewelers, or through futures contracts on a commodities exchange. Buying a gold exchange-traded fund (ETF) like the SPDR Gold Trust Shares (GLD) is another way that investors can gain exposure to the commodity.
- Contrarian Investing: Using contra market strategies can help contrarian investors profit against the crowd. Some fund managers believe that taking a long position in an aging bull market is the "crowded trade," meaning there is little room for new money to push the market higher. Instead of taking the obvious trade, the contrarian investor may look for investment opportunities that outperform if the broader stock market starts to fall, for instance, purchasing an ETF that returns the inverse performance of the Standard & Poor’s 500 (S&P 500) index. There are many inverse ETFs that rise in price when the underlying asset falls in value. (For more, see: How to Profit by Going Contrarian.)
- Diversification: Using contra markets can help an investor diversify. Holding only stocks that move in the same direction may work well when the stock market is rising, but when it falls so will all the holdings in the portfolio. Adding some stocks or other assets that have a low correlation, or negative correlation, to the stock market may help level out some of the ups and down in the portfolio's returns.
Advantages of Investing in Contra Market Sectors
During bull markets, cyclical sectors such as technology and financials perform well and get more expensive in terms of price, while contra market sectors such as consumer staples and utilities underperform. This provides investors with an opportunity to accumulate contra market stocks at lower prices and more attractive valuations. For example, as the U.S. economy performed well in the first half of 2018, technology FANG stocks outperformed the broader market. As a result, utility stocks were out of favor and subsequently cheaper. This may have attracted some contra investors to start accumulating positions in these underperformers in the hopes that they will perform better in the future. (See the Q&A: What is the difference between cyclical and non-cyclical stocks?)
Disadvantages of Investing in Contra Markets
While contra markets provide a potentially safer or more profitable place to be when the broader market or economy changes direction, holding contra assets during a major bull market could mean missing out on big returns from the broader market. Over a 5 year period between May 2014 and 2019, the SPDR S&P 500 (SPY) returned over 50% while the SPDR Gold Trust Shares (GLD) returned -3%. Taking part in the major bull market in stocks was a more prudent play than hoping gold would find its footing.
Example of a Contra Market: Gold
Gold has a weak correlation with the S&P 500 stock index. At times the correlation is negative, other times it is positive, and tends to oscillate back and forth. Many investors like to hold gold as it is viewed as an outperformer during tough times for the stock market. Yet that isn't always the case.
When the S&P 500 rose in 1995 to 2000, gold declined and had a negative correlation. The S&P 500 then fell from 2001 into late 2002. Gold started rising while stocks were falling, trading relatively flat and then picking up steam to the upside in mid-2001. So in this case, switching to gold would have paid off.
The chart below shows the SPDR S&P 500 ETF versus gold futures (blue line), with the bottom indicator showing the correlation between the two assets.
From early 2003 to mid-2007 stocks and gold both rose. Stocks flattened out for most of 2007 while gold rose. For this period, gold was favorable as stocks where topping. Stocks and gold both sank in 2008, but gold turned higher earlier than stocks and ran to upside into the 2011 high.
The S&P bottomed in early 2009 and continued to rise into 2019, with several corrections. Gold peaked between 2011 and 2012, and then went into a downtrend in 2013. Between 2014 and 2018 gold moved sideways, and did not provide a safe haven during the 2015 stock market correction as gold also fell during that time. In 2018, while stocks experienced a correction, gold also fell, although it experienced a small rally prior to the stock market bottom.