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The only attractive areas that remain true contrarian plays

06 July 2017

IG’s Chris Beauchamp outlines the three areas investors interested in value opportunities should take a look at for the second half of the year.

By Jonathan Jones,

Reporter, FE Trustnet

UK equities, oil stocks and miners are the only areas that are attractive contrarian plays, according to IG head of market analysis Chris Beauchamp.

Last year the value trade came roaring back into fashion, outperforming the growth style for the first year in five. Indeed, as the below shows, the MSCI AC World Value index returned 34.28 per cent in 2016 while the MSCI AC World Growth index returned 23.18 per cent.

Performance of indices over 5yrs

 

Source: FE Analytics

However, value stocks have again struggled in 2017, with the index returning 3.56 per cent against the growth index’s 10.20 per cent return.

For those investors still confident that the value rally can continue despite a disappointing first half of the year, IG highlighted three areas that could be due for a rebound.

 

UK equities

The first area Beauchamp suggested is UK equities, which he said are now unloved enough by global investors to be classed as contrarian.

“People are wondering about where the next strong performance from markets will be and I think there’s a strong argument to say that the UK is particularly one to watch out for if only perhaps because it is the contrarian play at this point,” he said.

Sentiment has been dampened further in recent months as investors were put off by the disappointing result in the general election – with a hung parliament followed by a costly deal with the Democratic Unionist Party (DUP).

This has joined the longer-term concerns over the UK’s decision to leave the European Union – decided by last year’s referendum – which could see the UK lose access to one of its largest trading partners.

“That has made people very wary of UK stocks relative to the likes of Europe and the US as well,” Beauchamp said.

Indeed, in a recent BofA Merrill Lynch fund manager survey the most popular trades were in Europe and the US, as the below shows.

The longs & shorts relative to Global Fund Manager Survey history

 

Source: Bank of America Merrill Lynch Global Fund Manager Survey

“There was much talk earlier in the year about the eurozone outperforming US stocks,” Beauchamp said, noting that while the performance this year in Europe has been strong the US has struggled.

“So if you are looking for the unpopular trade – and it’s no bad thing to look out for the areas that are unloved – it would be the UK stock market which is right at the bottom and quite low compared to where it has been previously,” he added.

“If only because you are not blindly following the herd, maybe the FTSE 100 and 250 are both indices to look out for as their time could be upon us once again in the second half of the year and may leave European markets in the dust.”


 

Miners

Along with the UK market, Beauchamp highlighted two specific sectors that remain attractive contrarian plays with miners looking particularly appealing for the long-term value investor.

“The wheels have come off it in relatively spectacular style actually this year but I think you could see further strength coming through because the foundations of the rally are still there,” he said.

Performance of index over 10yrs

 

Source: FE Analytics

As the above shows, the market rallied strongly in 2016 from its lows at the end of 2015 as demand picked up and concerns over a slowdown of growth and spending in China subsided.

Yet the sector has slipped back so far this year and remains a long way off the peaks seen in 2008 and 2010.

However, Beauchamp said this should be seen as a positive for investors.

“It’s nice to see prices have eased off a bit from where they were because there was a sense that the rally had got a little too parabolic, certainly in the short term,” he said.

“There was a need to adjust to the reality that metal prices weren’t going to rise as quickly as people thought but they are still on a broader upward trend and you have the demand to go with it.

Specifically, the IG analyst added that base metals fundamentally look a lot more attractive than the precious metals at the moment.

“They can pivot off the idea that the global economy continues to get better and demand continues to ramp up,” he said.

“They’ve clearly gone through that difficult period of selling off assets and have cut back on production to some extent but that has moderated slightly in the last few months.

“Base metals look more engaging than gold and thus you look towards big diversified companies that give you that security but give you a yield as well while you’re at it.

“They still look fundamentally attractive, they are not overvalued at current levels and are a lot cheaper than they were five or six months ago.”


 

Oil

The final area he sees good value in is the energy sector, with the well-documented sharp decline in oil prices hitting the oil majors in recent years.

Indeed, as the below graph shows, the oil price has slumped over the last decade, falling 72.87 per cent from its highs in 2008. The current Brent crude spot price is $48.43 per barrel.

Performance of Brent crude over 10yrs

 

Source: FE Analytics

This has impacted the oil sector, taking the UK as an example, with the FTSE All Share Oil & Gas index underperforming the wider FTSE All Share by 24.23 percentage points over the last decade.

“There’s a lot of reason to be longer term cautious on oil and I don’t expect it to go anywhere near the highs that we’ve had over the last few years, but I think at $40 per barrel it probably looks due a rebound in the short term,” Beauchamp said.

He added: “[In this area] I still think you combine that with the idea of investors hunting for yield so you look at the likes of BP and Shell.

“That’s not a surprising thing to say – that you pick the oil majors [over the minors] – but they’ve done their cost-cutting and their hard work and they continue to look attractive, not least because of the yield.”

Indeed, the IG analyst noted that due to the extreme levels of cost-cutting the large oil firms have been forced to undertake as a result of the low oil price, worries about their dividends – which dominated the sector earlier in the year –have receded and should continue to recede into the second half of 2017.

“They remain ones to watch out for those investors looking for that steady, reliable income that will keep them afloat in periods of continued declines in bond yields,” he concluded.

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