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3 Ideas for Contrarians

Those with the right constitution may find opportunity in these pockets of the market.

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Stan Lee, legendary creator of countless Marvel comic book superheroes, didn't follow the crowd. He was unconventional. Unlike other comic book heroes, Lee's protagonists--Spiderman, Iron Man, and the Incredible Hulk, among them--had flaws. Lee's heroes overcame their flaws to do great things. 

When it comes to investing, few of us are like Stan Lee. It's tough to go against the crowd when your money's on the line. Herding--or following said crowd--is much easier to do. Buying what others aren't, or when others aren't, takes a special constitution: the constitution of a contrarian.

There's no single lens through which contrarians operate, and there's no one way to be contrary. Some short stocks they deem overvalued. Others, like those in Morningstar's Manager Research group, use fund flows as a contrarian indicator; their annual study suggests buying unpopular categories and selling popular ones.

In homage to Stan Lee and for contrarian investors everywhere, today we're sharing some of Morningstar's best ideas from areas of the market that have been out of favor this year. Specifically, we've isolated categories and sectors with the worst year-to-date returns and then named some of our analysts' favorite picks in each.

Of course, these contrarian ideas aren't for everyone, and they shouldn't dominate a portfolio. They're best at the fringes--kind of like Hawkeye.

Idea 1: Domestic Small-Value Funds
Despite an upswing in recent weeks, the Morningstar U.S. Small Value Index is bringing up the rear this year among all domestic Morningstar style indexes. It's in the caboose for the trailing three- and five-year periods, too.

Value investing's woes have been well-documented. Still-impressive earnings have continued to propel many growth stocks--especially large-growth names--leaving traditional value fare of all market capitalizations in the dust. Yet as Morningstar's John Rekenthaler has noted, despite growth's dominance, the psychological reasons to believe in value investing still exist.

     {Deep Dive: Value Investing: A Deep Dive Into Performance}

Those with the fortitude to add a domestic small-value fund to their portfolios can begin their search by narrowing the field to Morningstar’s top-rated funds in the category.



Most of the funds on the list are actively managed. Vanguard Small Cap Value Index (VISVX) is an exception: This passive strategy tracks the market-cap-weighted CRSP U.S. Small Cap Value Index. The two DFA funds on this list also pursue passive strategies.(DFA funds are available to individual investors only through a qualified financial advisor or select platform such as a 401(k).)

Idea 2: Healthcare Stocks
The healthcare sector is up about 13% for the year to date as of this writing, which is nothing to sneeze at. However, the broader market as measured by the S&P 500 is up about twice that.

“As potential changes in U.S. healthcare policies have become more elevated with politicians increasing rhetoric for the upcoming presidential election, increased uncertainty has weighed on the sector's relative performance,” explains sector director Damien Conover.

     {Deep Dive: Healthcare: Political Uncertainties Have Weighed on the Sector}

More than two dozen high-quality healthcare stocks are trading in buying range as of this writing, with ample opportunities among drug, biotech, healthcare provider, and managed care organization industries.



Those who’d rather invest in a larger pool of healthcare names have a couple of highly rated funds to choose from.



Both Vanguard Health Care (VGHCX) and Fidelity Select Health Care (FSPHX) offer pretty broad exposure to the sector, while PGIM Jennison Health Sciences (PHSZX)--currently closed to new investors--skews toward smaller companies and biotech names.

Idea 3: Energy Stocks
The energy sector is the year’s worst performer as of this writing, up just 2% for the year. Although the attack on Saudi Arabia’s Abqaiq oil facility several weeks ago led to a temporary improvement in oil prices, things soon settled back down. (Historically, energy stocks and oil prices move in tandem.) Our forecast is for a midcycle price of $55 per barrel.

“We see particular opportunity in oilfield-services stocks, which remain at valuation levels that we have not seen in some time,” notes Jeffrey Stafford, director of equity research.

     {Deep Dive: Energy: Opportunities Remain Following Saudi-Related Oil Volatility}

As in healthcare, more than two dozen high-quality energy stocks are trading in buying range as of this writing. While oilfield services stocks naturally make the list, so to do many midstream and exploration and production names, as well as some of the major integrateds.

     {Deep Dive: Integrated Oils: Where to Find a Bevy of Dividend-Stock Opportunities}


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Susan Dziubinski does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.