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Don’t go to the dogs in 2018

Being a contrarian sounds easy: look at what the investment herd is thinking and bet against it. But, as John Stepek explains, it’s not that simple.

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Beware of the dogs

Being a contrarian sounds easy. Look at what the investment herd is thinking, then bet against it. Sell what's popular, and buy what's hated. Sadly, it's just not that simple to make money. Each year, Citigroup analyst Robert Buckland looks at what would have happened had you bought the ten worst performers among the 250 biggest global stocks of the previous year, and shorted the ten best, says Robin Wigglesworth in the Financial Times.

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The results are not pretty. Other than during major turning points (such as the tech bubble or 2008), this strategy would have done very badly. For 2017, it lost 18%, while most major markets saw double-digit gains. Since 1997, the strategy has lost 90%.

Contrarianism is then a lot harder to pull off than it looks. Markets unquestionably overreact, and it's this gap between reality and the market's distorted view that contrarians aim to exploit. But that doesn't mean every popular stock is popular for the wrong reasons, nor that detested stocks are fated to recover. A stock that has fallen by 80% from a recent high might be unfairly marked down or it could be the first stop on the way to bankruptcy.

So merely buying the biggest losers and selling the biggest winners on an arbitrary date, with no regard for fundamentals, is not contrarian it's silly. Contrarianism is more of a mindset than a specific strategy, and one that involves a lot of painstaking research to back up your "out-of-consensus" view.

No strategy works forever

One mechanical strategy with a contrarian tinge that might deliver market-beating returns is the "dogs" strategy. Invest equal amounts in the ten FTSE 100 shares with the highest dividend yields (indicating they're somewhat out of favour), then hold for a year. For example, in the 15 years to the end of January 2017, the "Footsie dogs" portfolio compiled by Money Observer enjoyed an annual average total return of just over 12%, compared with 4.8% for the FTSE 100. Last year's picks are also holding their own.

One thing to be aware of this year, however, is that dividend cover (which measures how comfortably firms can meet their dividend promises) for the index is tighter than at any point since before the 2008 crisis, according to AJ Bell. In other words, there may be a greater chance of dividends being cut or dropped in the year ahead. Perhaps the real lesson is that, if you want to beat the market, there's no easy way around doing the legwork.

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