Five ways to go against the herd

The key is to separate risks from perceptions

Investing psychology can be a lot like those wildlife documentaries where one needs to tuck in with the herd in order to survive and not be someone’s dinner.

Unfortunately, in t he markets, unlike in nature, joining the herd is often where the most danger lies since we end up buying at the tops and selling at the bottoms.

We often find that the best opportunities are in markets or sectors where there are maximum levels of pessimism. The key is to identify if the perceived risk is greater than the real risk.

In today’s environment, there are five such opportunities in emerging markets, oil and gas, Canadian REITs, Canadian preferreds and the Canadian dollar.

Emerging markets

Investors have been s el l i ng China and other emerging markets while piling into U.S. stocks at the same time, while ignoring the fact that the U.S. is China’s largest trade partner.

This trend is expected to continue. The Institute of International Finance is forecasting that emerging-market assets will record a net outflow in 2015, the first time that has happened in 27 years.

As a result, emerging markets have now been sold down to 2009 levels while the S&P 500 remains near all-time highs.

This is not to suggest there aren’t any risks here — China’s growth has fallen to its slowest pace in 25 years — but perhaps they are already reflected in current valuations.

Oil and gas

Oil prices in the second week of September dropped on a report by Goldman Sachs that proclaimed the possibility for US$20-a-barrel oil.

The bearish call grabbed a lot of headlines, but it wasn’t surprising, especially given the downturn in China, which is one of the largest consumers of oil and other commodities.

That said, we’ve already worked through six years of a global oversupply problem caused during the so-called commodity super-cycle from 2000 through to 2008.

We also are very encouraged by seeing a hostile takeover happen in the Canadian market as it could provide the spark needed to spur muchneeded consolidation in the sector.

Don’t kid yourself: the upside could be very material. Simply look at the 50-per-cent rally in Canadian Oil Sands Ltd.’ s share price in the past week.

Preferred shares

Another area that is looking interesting is the Canadian preferred share market, which has been obliterated in the past year thanks to retail adviser panic selling. In particular, rate resets have been hit the hardest with many selling off 25 to 45 per cent, depending on the reset date.

We believe that the massive spread to equivalent-termed corporate bonds makes preferred shares a great value opportunity for the patient longer-term investor.

There is also a tax benefit in owning preferreds over bonds, which are taxed at an investor’s highest marginal tax rate.

Canadian dollar

The bright spot — and likely the only source of positive returns — in the past 12 months has been for investors lucky enough to hold actual U.S. dollar positions given that the currency has rocketed more than 17 per cent against the Canadian dollar.

David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates Inc., recently provided some great analysis that showed we are about to see the impact of the falling currency with Canada’s Q3 GDP growth tracking to outperform the U.S.

Canadian REITS

Canadian REITS are somewhat flat on the year, thanks to some attractive yields in excess of five per cent, but they still remain 12 per cent below their 52-week highs on the whole.

Interestingly, they have fallen in value despite two Bank of Canada rate cuts as investors have chosen to focus on the potential for a U.S. rate hike instead.

We like the sector for its strong yield, and its recent sell-off was unfounded in our view.

It’s also a sector similar to the preferred market in that it’s heavily owned by the retail adviser community and we have often found it very profitable to be on the other side of their trades.