How Could Investors Utilize Contrarian Strategies to Adjust Portfolios During Market Downturns?

Heightened geopolitical concerns and deflated hopes for lower interest rates kept major US stock indices under pressure. Last week, the Nasdaq fell 6.1%, the S&P 500 index fell by 3.2% and the VIX index rose by 9.1%. Among sectors, the Technology sector declined by 7.2%, the Utility industry rose by 1.56%. In volatile markets, diversification and the use of multiple instruments are crucial.

■ Seasonal pattern suggests U.S. stocks may underperform in May

Historical patterns show that U.S. stocks have often experienced lower performance or underperformed during the summer months. Several theories attempt to explain this phenomenon; one suggests that during the summer months, trading volumes decrease as investors, including traders and fund managers, take vacations. Lower volumes can lead to higher volatility and less market momentum. Another theory posits that companies' fiscal year-end activities and other cyclical factors contribute to this pattern.

However, it's important to remember that this is not a rule, but rather a historical tendency that does not occur every year. While some investors might adjust their strategies based on this seasonal pattern, it is essential to consider the broader market context, including economic indicators, corporate earnings, and other factors that can influence stock performance. Moreover, basing investment decisions solely on seasonal trends without considering current market conditions and one's long-term investment strategy might not yield the desired results.

■ Which industries are worth investing in currently?

Charles Schwab's monthly stock sector outlook rated Energy, Financials and Materials as Outperform. Meanwhile, Information Technology is in last place based on factors, but the team continued to rate it as Market-perform. Real Estate remains Underperform based on weak fundamentals, including high interest rates and still-rising vacancy rates.

The Utilities sector has tended to perform relatively better when economic growth slows, as consumers usually cut spending on other items before they stop paying utility bills. However, the outlook pointed out that the sector is heavily indebted, especially relative to cash flow. Economic data have come in better than expected. Higher Treasury yields can lessen the attractiveness of Utilities stocks.

Similarly, Blackrock expects sector performance to diverge and prefers the industrial, materials and energy sectors over consumer goods. Commodity production has been cut alongside better-than-expected demand. Prices of metals key to the low-carbon transition, like copper, have rebounded and could rise further. Blackrock sees AI advances stoking the buildout of data centers, resulting in major commodity demand.

■ What are the contrarian opportunities for U.S. stocks?

In the U.S. stock market, investors can use contrarian strategies to profit when the market or specific stocks are declining, or to capitalize on the expectation of a downturn during overheated market conditions. Here are some common contrarian investment strategies:

1. Short Selling: Short selling involves borrowing shares and selling them immediately with the expectation that the stock price will fall. The investor then buys back the shares at a lower price to return them, pocketing the difference as profit.

2. Inverse ETFs (Exchange-Traded Funds): These funds are designed to perform in the opposite direction of the market on a daily basis. For example, if the S&P 500 index falls by 1%, an inverse S&P 500 ETF might rise by approximately 1%.

3. Put Options: Buying put options gives the investor the right to sell a stock at a predetermined price within a specific time frame. If the stock price falls, the value of the put options increases. Investors can profit by selling the options or exercising them at the strike price.

4. Index Futures: Investors can short sell index futures contracts, such as those for the S&P 500, NASDAQ-100, or Dow Jones Industrial Average, if they anticipate a market downturn.

5. Defensive Stocks or Sectors: In anticipation of a market downturn, investing in defensive stocks or sectors that typically exhibit less volatility, like utilities, consumer staples, and healthcare, may offer some protection.

However, due to the nature of their leveraged and daily rebalancing strategies, some of them are typically not suited for long-term holding and are primarily intended for short-term trading purposes.

Despite the recent market decline, the pickup in manufacturing activity shown by the PMI means that the profit recovery in the technology industry is likely spreading to other industries. The momentum recovery in sectors beyond tech is part of the broadening out of stock index performance.

Blackrock still went overweight overall U.S. stocks on a tactical horizon of six to 12 months earlier this year. The latest report noted “We see earnings forecasts holding up this year – but companies will need to deliver on high expectations. Analysts see 2024 earnings growth of 11% – above the 7% historical average, according to LSEG data.”