How to be the ultimate contrarian investor in 2016

It's hard to beat the crowd when you're a member of the herd. To this end, we've compiled six ways investors can seek to escape the consensus Wall Street bubble by examining some of the more "out-of-the-box" calls for the year ahead. Be warned: It's difficult to be both different and profitable.

"Simple contrarian strategies can perform spectacularly well at big macro turning points, but they underperform the rest of the time," cautioned equity strategists at Citigroup led by Robert Buckland. "Most of the time it just makes you poor."

If your heart is still set on taking the road less traveled, here are the ways to do so in 2016:

From divergence to convergence
This year, Wall Street has been enthralled by the divergence trade-that is, the decoupling of the Federal Reserve from other major central banks and its subsequent effect on interest rate differentials and currency valuations.

But this theme may have been priced into financial markets too thoroughly when it comes to the US and European Union, setting the stage for a convergence trade in 2016.

Count Deutsche Bank in the camp that considers the divergence theme near its best-before date.

"The end of 2015 is marked by the unusual combination of the Fed likely to tighten policy, while the [European Central Bank] delivered additional easing (albeit below heightened expectations)," wrote strategists led by Francis Yared in a report dated December 10. "While this policy divergence could persist early in the year, there should be some partial convergence later in 2016."

"Using the Fed's forecast of the US unemployment rate and the ECB's forecast of the euro area unemployment rate we are currently at peak divergence between the Fed and the ECB," added Torsten Sløk, Deutsche Bank's chief international economist, in a note published the following day.

Deutsche Bank's convergence trade recommendation is to buy 30-year US Treasuries and sell German bunds of the same duration.

Moreover, in accordance with the notion of "peak divergence," analysts at UBS expect the euro to end 2016 at 1.17, relative to the greenback.

"What we have been highlighting is the pricing is very extreme," Themos Fiotakis, co-head of rates and foreign-exchange research at UBS's investment bank, told Bloomberg's Simon Kennedy. "The market is pricing a remarkable confidence in a full Fed tightening cycle and on the other hand recessional conditions in the euro-area."

The consensus among analysts surveyed by Bloomberg is for the euro to weaken in the first half of 2016 but to end the year virtually unchanged vs. the dollar.

Goldman Sachs, however, anticipates that the divergence trade has room to run in the foreign exchange market. In less than 12 months, Chief Currency Strategist Robin Brooks expects the euro to fall to parity against the greenback.

 

Ring 10 bells for the 10-year
In October, Steven Major, HSBC's head of fixed-income research, took a hatchet to his end-2016 US Treasury yield forecast, making the team's call for the 10-year the lowest on the Street, at 1.5 per cent.

Major said that a soft global-growth environment, a Fed tightening cycle that will prove more gradual than the dot plot, and spillovers from accommodative policy deployed abroad should put a cap on longer-dated US yields.

"Our lower yield views are part of an international story, one that sees the ECB stuck in dovish mode well beyond the end-2016 forecast horizon and headwinds from some emerging markets," he wrote.

Conversely, economists at CIBC World Markets, RBC Capital Markets, Raymond James, High Frequency Economics, and Amherst Pierpont are among a group that expects the 10-year Treasury to be yielding more than three per cent at year-end 2016.

The median forecast among analysts surveyed by Bloomberg is for the 10-year yield to rise to 2.75 per cent by the end of 2016.

Underweight health care
Health care's rough patch in 2015 centered around certain key figures (namely, Martin Shkreli, Michael Pearson, and Hillary Clinton). But for Ian Scott, Barclays head of equity strategy, the reasons to underweight the sector in 2016 are more top-down in nature.

"Rising bond yields, inflation expectations and decent economic growth should see the hefty safety premium investors are paying for these sectors [health care and consumer staples] reduce," he wrote in a report dated November 19.

Based on historical correlations with the US 10-year Treasury yield, the strategist found that health care tends to underperform when yields are moving higher.

For a global equity portfolio, Scott recommends exposure of just 3.1 per cent to health care vs the benchmark weighting of 12.2 per cent.

In the US in particular, Scott's peers are much more bullish on the outlook for health care. Equity strategists at UBS are overweight in the sector, citing its "earnings momentum, strong top-line growth, attractive dividend yield and potential for further share buybacks" in a report dated November 10.

David Bianco, Deutsche Bank's chief US equity strategist, concurs with that call.

"We expect six per-cent sales growth from health care in 2016, well above nominal GDP and S&P 500 sales growth," he wrote. "We expect six to nine per cent EPS growth. We doubt the S&P delivers better growth." In the run-up to and commencement of liftoff by the Federal Reserve, the US Treasury curve flattened, with yields on two- year sovereign debt rising, while its 10-year counterpart treaded water.