XLU - Done Well With Recent Winners? You Are More Likely To Outperform With These Investments

2023-10-13 11:08:25 ET

Summary

• Contrarian investing involves going against the majority and choosing less popular or beaten down investments.
• Large growth funds holding stocks such as Apple, Microsoft, and Amazon have seen significant gains as have highly popular S&P 500 funds.
• Consider actively managed mutual funds like PrimeCap Odyssey Stock Fund and/or the utility sector for contrarian bets.
• Going against the majority can often lead to better results than funds that have already shined.

Have you ever heard the term "contrarian," especially as applied to investing? It means going against what the majority of investors have come to believe. So, a contrarian investor opposes or rejects what his or her fellow investors seem to believe as to which investments have the best prospects, and instead, chooses those that would seem to be underdogs.

Right now, we have many ETFs and mutual funds that would seem to be your best choices, based on past performance and some projections as to the future potential improving course of the economy. These funds would therefore seem to be the logical choices for investors going forward. However, many years of investing experience has shown me that often even the best forecasts for the economy and future investment performance turn out to be incorrect.

Two recent examples include the 2020 and 2021 outsized gains for S&P 500 funds, such as Vanguard S&P 500 ETF ( VOO ) during the first two years of the pandemic, and the bond market's near zero performance during the same period. I, and many others, would have expected stocks to do poorly and bonds to shine. Those who would have gone against what appeared to be conventional wisdom and invested mainly in stocks and tended to avoid bonds won out over those who chose to sell stocks and think their money was safer in bonds.

Of course, no one could have known for sure in advance that would have been the outcome during this period. As they say, hindsight is 100 percent, while guesses as to what will happen in the future are, just that, guesses.

As to the present, our judgment might tell us that some funds, such as Vanguard Growth ETF ( VUG ) or, its equivalent, Vanguard Growth Index Admiral ( VIGAX ), will continue to be an investor's best choices. After all, each are up about an incredible 30% so far this year. Large growth funds hold stocks such as Apple (AAPL), Microsoft (MSFT), and Amazon (AMZN), and a high percentage of technology stocks. If they also hold Nvidia (NVDA), they hold a company that accounts for more than 70% of artificial intelligence (A.I.) chips, according to the N.Y. Times.

Of course, A.I. and its associated buzzwords, such as machine learning, chatbot, predictive analytics, etc. are the talk of the computer world, and now show up quite frequently in the media as well. Nvidia stock is up an astounding 213% this year alone. A little more down to earth, Apple is up 37%, Microsoft the same, and Amazon over 52% (results here are as of earlier this week).

I congratulate those holding these individual stocks as well as those with such large growth funds in their portfolios. There possibly has been no easier way to grow rich when held in sizeable amounts.

For those who continue to believe that such funds are almost certainly the best places to be, you are likely in the majority. If, however, you have some big doubts, you are likely a contrarian. Let's now discuss two contrarian bets.

1. The PrimeCap Odyssey Stock Fund ( POSKX ) may not seem be a contrarian bet. But it has only $5.5 billion in total assets as compared to, say, VUG's $91.4, and therefore, is relatively small in size. It is considered an actively managed, large blend fund, rather than a large growth one and is one of the few funds of the PRIMECAP family of funds that is still open to new investors.

These days, most people choose to invest in index funds, ETFs in particular. But to be contrarian, you might want to consider at least some actively managed mutual funds.

While POSKX has significantly trailed the S&P 500 over the last five years, during the last three, it has beaten it by more than 2% annually. Perhaps this is because of its relatively stronger position in health care stocks which are considered defensive stocks.

According to Investopedia, a defensive stock is one that "provides consistent dividends and stable earnings regardless of the state of the overall stock market." Continuing the quote, "There is a constant demand for their products, so defensive stocks tend to be more stable during the various phases of the business cycle." POSKX currently has a total of 29% of its portfolio in defensive stocks while VUG, for example, only has about 11%.

Also, in this mutual fund's favor, is that its five long-term active managers each have more than one million dollars of their own money in the fund. It also has a bigger tilt toward undervalued value stocks than, say, ETF giant VOO with a PE ratio of 15.5 as compared to VUG at 29.5, or ETF giant, VOO, with about 20. While lower PEs are not necessarily a guarantee of better returns ahead, it is widely understood that once PEs get way above their long-term average of about 20 to 25, they may be considered overvalued.

2. The utility sector has been the worst performing of the 11 sectors market sectors so far this year according to Yardeni.com. As of 10/9, Morningstar's US Utility Index of utility funds has shown a minus 16.0 return. And according to a recent article on Morningstar.com, utility stocks are trading at the biggest discount since the end of the 2007-2009 and the 2020 bear markets, meaning the sector is extremely cheap. To invest in this sector would be a truly contrarian bet.

Why have utility stocks done so poorly this year? Perhaps it is because with interest rates on cash and bonds so high, an investor seeking income can easily earn around 5% as compared to close to 4% with utility stocks with much lower risk. Another reason suggested for the sector's poor performance this year is that as interest rates rise, utility companies cost of doing business increases more than most other companies because utilities must issue considerable debt to maintain their infrastructure to deliver their services, resulting in a higher cost of financing.

As I pointed out in my Aug. 2023 article on Seeking Alpha, based on 18 past years of data, utility stocks, as represented by the Vanguard Utilities ETF (VPU), were one of the best places to invest in when inflation exceeded the Fed's 2% target. VPU had an average one-year return of 8.13% during such periods. Vanguard's most popular ETF, Vanguard Total Stock Market ETF ( VTI ), had an average one-year return of only 3.0% during such periods. Note: Investors may also want to consider Utilities Select Sector SPDR® Fund ( XLU ), the largest utility ETF.

Since utility stocks tend to do well in recessions, recently, market participants now seem to fear one less than just a few months ago. Thus, utility stocks have floundered during this recent period. If the Fed begins to cut rates, that would almost certainly aid utility stocks.

To summarize, while it is never easy to go against the crowd and bet on less popular or beaten down stocks, the possibility of greater rewards are the potential payoff for contrarian investors.

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