Finding gems in the rubble: A contrarian’s guide to 2025 markets

Nathan Rothschild’s famous encouragement to ‘buy when there is blood on the streets’ may seem heartless, but it has generally been an effective way to buy when markets are low. It imposes a natural price discipline and forces investors to look in the unloved corners of the stock market for bargains.

However, it has become a more difficult strategy in recent years, where inflows into passive products have slowed price discovery, and supported the largest stocks in the market. Unloved parts of the market have often stayed unloved, while expensive stocks have become even more highly valued.

There are two key problems with the contrarian approach: the first is that a sector or region has been bad for a reason, and may be only part way through its slide. This is the ‘catching a falling knife’ issue. The second is that a good sector remains unloved indefinitely, with no-one taking any notice. This is what has been happening to some extent in the UK market in recent years.

That said, good contrarian managers have still managed to eke out good returns even in these tough conditions. Most value managers are natural contrarians, and managers such as Alex Wright on Fidelity Special Values, Nick Kirrage on Schroder Income and Schroder Recovery, and Alex Cutler on Orbis Global Balanced have all delivered strong returns by looking at areas where others would rather not.

If investors were to take the same approach this year, they would be looking at some very unlovely areas. In 2024, the worst areas were Latin America, where the average fund was down 25% and UK gilts, where the average fund was down 3.7%*. Property and Europe ex UK sectors were also weak.

Latin America

Latin America is always a volatile market, and sharp drawdowns are often followed by rapid upswings. It has been a tough year for the region in spite of hopes that Mexico would receive a boost from the ‘nearshoring’ drive across the world, and Brazil would benefit from falling interest rates and its diplomatic fluidity in being able to trade with China and the US.

Austin Forey, manager of the JPMorgan Emerging Markets Trust, is still backing a number of companies in Brazil, but admits this has hurt performance: “In Brazil, recent actions by the government, specifically the announcement of a disappointing fiscal package and income-tax exemptions for low-income individuals, led to concerns that the government could inject further stimulus into an already overheated economy, exacerbating inflation pressures. Consequently, overweight exposure to Itau Unibanco and NU Holdings, a digital bank, hurt.”

However, Brazil – by far the largest weighting in Latin America – should benefit from lower interest rates in the year ahead, and valuations now look attractive. The MSCI EM Latin America index is on a forward P/E of just 7.9x and its dividend yield is 6.3%**. The team on the Invesco Global Emerging Markets fund continues to back the sector, with a significant overweight position in Brazil***. However, it remains an area not for the faint-hearted, and allocation may be best left to a capable emerging markets manager.

UK Gilts

If the UK government and the Bank of England are struggling to predict the direction of gilts, there are some risks in investors trying to do so. It is clear there are worries that the government has lost control of borrowing, and is facing a stagnating economy. 10-year gilt yields have risen from a low of 3.8% in September to 4.8% today****.

Ben Edwards, manager of the BlackRock Corporate Bond fund, believes they have been harshly treated. “There is growth that looks more like Europe than the US, and there are yields that look more like the US, and since the election, there is a lot more policy certainty.” He points out that in June last year, core inflation was 6.8%, the Bank of England hadn’t started cutting rates and the market was pricing three or four extra hikes. Now, core inflation is half of that, the Bank of England has cut rates twice and the market is pricing more cuts. Yet yields are higher.

Bryn Jones, manager on the Rathbone Ethical Bond fund, is not so sure: “I think the Government has lost control of borrowing, and we have seen a slow burn rising yield.” On whether gilts could still be a good investment, he says: “As a result of yields rising so much, the duration is less. Interestingly, if you look at forward Sharpe ratios of gilts, they have potentially not been this attractive for decades.” He adds that while gilts provided little insurance and high correlations to equities when yields were low, they could now act as a real return over inflation and a decent hedge to equities. However, he adds: “There might be more pain in the short term with UK gilt auctions over coming weeks, if the recent £2.25bn auction of 30-year gilts at 5.2% is anything to go by.”

Property

Marcus Phayre-Mudge, manager of the TR Property Trust, admits that the recent performance of the asset class is ‘puzzling’, given that – until recently at least – interest rates were coming down. Property is a leveraged asset class and usually responds positively to falling borrowing costs^.

Nevertheless, he remains optimistic that the sector will turn. He says: “The interest rate cycle has peaked, but we know there is a severe undersupply of prime space in so many of our markets. Independent valuers are still behind live market pricing, but catching up very quickly. Valuation decline is slowing and in some cases, actually improving. Where valuations are declining it is already fully discounted in the share prices. That’s what’s really interesting to us at the moment.” He says earnings for property companies are also starting to improve.

Much will depend on the direction of interest rates. If interest rates continue to come down, investors may be more confident to invest in property once again and valuations could start to recover.

Europe ex UK

Europe wasn’t a disaster last year, but compared with the lofty gains from the US, investors may have been disappointed. The average Europe ex UK fund returned just 1.7% in 2024, compared with 22% for the average North American fund*.

Looking to the year ahead, the Eurozone economy is perhaps not as bad as it is billed, with GDP rising 0.4% in the three months to September 2024, its strongest growth rate in two years^^. Inflationary pressures are not as acute as elsewhere, and further interest rate cuts appear more likely than in the US or UK. However, pressures remain for Europe this year, with uncertainty over Donald Trump’s tariffs presenting a headache for European companies.

Sam Morse, manager of the Fidelity European fund, says he is underweight areas such as autos and spirits, which could be most heavily affected by the tariff regime, but the fund’s holdings in luxury goods companies could be affected. However, he says fiscal stimulus in the US and China could be positive factors in the year ahead^^^. He is focusing the fund on companies with sustainable dividend growth, many of which generate their revenues outside Europe.

The technology giants have been dominant for so long, a lot of the market has been left behind. This has created plenty of opportunities for contrarian investors, the problem has been knowing if the market would turn. The market has been diversifying over the past few months, and these areas may yet have their moment in the year ahead.

*Source: FE fundinfo, calendar year performance 2024

**Source: MSCI index factsheet, 31 December 2024

***Source: fund factsheet, 30 November 2024

****Source: UK 10 year Gilt, at 13 January 2025

^Source: TR Property, 19 December 2024

^^Source: Trading Economics, Euro Area GDP Growth Rate, at 13 January 2025

^^^Source: Interview with Sam Morse and Marcel Stotzel, 8 January 2025