Contrarian Investing: Capitalizing on the Bearish Sentiment in Canada

Contrarian investing is an interesting strategy that can make some serious money for you. The idea is to take a position when most don’t. Of course, you should have a strong conviction and facts to support the contrarian positions.

Contrarian investing examples

When energy stocks lost substantial value during the recession triggered by the 2020 pandemic, investors could have bought an energy equity exchange-traded fund (ETF) like iShares S&P/TSX Capped Energy Index ETF, which grew investors’ money five-fold.

XEG and CNQ Total Return Level data by YCharts

Taking a position in XEG would have provided some diversification across the sector, thereby limiting the risk exposed to the individual companies. The largest holding in the XEG ETF is Canadian Natural Resources. Contrarian investors who took a position in CNQ instead would have almost six times their money. Investing in the Canadian stock market in this period would only have returned about 62% versus the approximate 400% total return in XEG and 500% return in CNQ.

Here’s a more mild but recent example. In the stock market dip over September and October, investors could have accumulated shares opportunistically instead of selling like most of the market. From the bottom in the last couple of months, the stock market has popped north of 5%. The selloff may have resulted from rising interest rates, which are increasing the borrowing costs of businesses and individuals.

XIU and BIP.UN data by YCharts

One contrarian stock, which sold off significantly in the market correction, was Brookfield Infrastructure Partners (TSX:BIP.UN). It rebounded about 23% from the bottom. Certainly, it was a scary slide for unitholders, especially for new investors who just started investing. This is why investors must be confident in their holdings and be prepared to hold on in a market downturn. The utility maintains a healthy balance sheet and sufficient liquidity for growth opportunities.

Capitalize on big dividend income in contrarian stocks

Brookfield Infrastructure Partners continues to be a good contrarian stock for big dividend income. To be exact, it pays out quarterly cash distributions that could taxed differently than dividends. Its cash distributions may consist of foreign dividend and interest income, Canadian interest income, and return of capital. Therefore, it may be simpler to hold it in a registered account like a Registered Retirement Savings Plan (RRSP).

The company is comprised of a globally diversified infrastructure portfolio that generates sustainable and growing cash flows to support its cash distributions. Recently, it acquired some data centres at good valuations. BIP has a track record in optimizing assets and selling mature assets for excellent long-term returns and then redeploying capital for greater risk-adjusted returns.

At writing, BIP trades at $36.97 per unit and offers a yield of about 5.7%. Although not as contrarian an idea as before, it’s still substantially undervalued with a discount of about 31%, according to the recently set 12-month price target across eight analysts on TMX.

You can also enjoy enlarged dividends from the big Canadian bank stocks, which bounced last week. The most contrarian bank stock, of course, is Bank of Nova Scotia (TSX:BNS), which is still down about 11% year to date.

Other than being exposed to housing market downturn risk and commercial real estate risk like its peers, the bank is also exposed to international markets that have higher risk. Its primary international exposure is in Latin America, including Chile, Mexico, and Peru. However, when these economies improve, the stock could also make a strong comeback potentially over multiple years. At $59.24 per share at writing, it offers a juicy dividend yield of almost 7.2%. Analysts believe the stock trades at a discount of about 13-15%.

Since stocks can sell off substantially with no warning, it would be smart to average into positions using commission-free trading platforms such as Wealthsimple.