Every year around this time, it’s not uncommon for financial market analysts to start thinking about the types of stocks they expect will outperform in the upcoming year. It’s a time when market pundits and newsletter writers begin typing out their top picks for the year ahead, while investors generally ponder which asset categories they think should be sought and avoided.
As the chief analyst of the Cabot Turnaround Letter, I’m faced with the task of figuring out which undervalued assets are likely to turn the corner and deliver meaningful gains over the course of the new year—and in most cases without the benefit of selecting stocks that already enjoy a significant momentum tailwind. And while the performance of short, bear, or inverse ETFs makes a contrarian case on its own, I believe there are better turnaround investments for the year ahead.
That said, there’s a certain benefit to using the contrarian principle when it comes to picking turnarounds, especially since out-of-favor or forgotten industries (or even entire markets) often exceed consensus expectations—especially when fundamental factors are in their favor.
The year to date has been very generous to investors, with the S&P 500 Index up 25% as of late November, which is on top of last year’s 24% S&P gain. What’s more, a substantial number of S&P sectors have turned in exceptional performances this year even as a large number of the most actively traded stocks have boomed in the wake of the U.S. presidential election.
It goes without saying that this makes for a tough act to follow in 2025. And while it’s tempting to indulge our normalcy bias and assume that “a trend in motion tends to stay in motion,” I think we should consider the contrarian case for next year. Even if the statistically improbable bearish case doesn’t play out, it’s always useful to at least consider the worst-case scenario in order to better make preparations for what could happen.
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A growing number of observers now see the equity market as being “priced to perfection.” In fact, those exact words were used in the headline of a November 13 CNBC article by Jeff Cox, which warned that “there is concern that the market is pulling forward gains now and could pay the price later.”
However, that same article concluded with a quote from investment strategist Jim Paulsen, who observed that market uncertainty (the so-called “Wall of Worry”) has often led to higher stock prices. Thus, what started as an ominous warning about a potential post-election downturn turned into an assurance, as the article ended with Paulsen’s quote: “I don’t think we’re falling apart and I don’t think the market’s all that far ahead of itself so much as people think.”
Yet another contrarian consideration is that investors are heavily positioned for a market melt-up. As a recent Wall Street Journal article put it, participants have lately “stampeded into funds tracking U.S. stocks” with index ETFs bringing in nearly $56 billion in the week to November 13—the second-largest weekly inflow since 2008, while one of the largest ETFs tied to the Russell 2000 Index attracted almost $4 billion in a single trading session earlier this month—the highest rate since 2007. The latter year, of course, immediately preceded the financial crisis that lay ahead.
Meanwhile, the Financial Times reported that the trading accounts of U.S. banks exceeded $1 trillion in this year’s Q3, which is the highest level since 2008 (again, immediately prior to the worst part of the credit crisis). FT further noted that the growth of trading funds had left the banks, “particularly the largest ones, more exposed to market moves than at any time since the financial crisis as they hold ever-greater inventories of price-sensitive securities.”
Additionally, WSJ noted: “Three of the top five days for trading in call options…have occurred [in November], according to options records going back to 1973.” This serves as a further warning from a contrarian perspective that perhaps the stock market really is “priced to perfection” and therefore vulnerable to a setback.
In view of the contrarian case for the bear to possibly emerge in the coming months, the temptation to view the ProShares UtraShort S&P 500 ETF (SDS) as a potential turnaround play for 2025 might just be too great to resist for some participants. Indeed, after declining 60% from its October 2022 high price (when broad market selling pressure reached a peak), SDS could almost be regarded as something of a “value” play for next year.
All things considered, however, I’m not in the business of assuming the worst-case scenario will happen. Nor do I consider it prudent to predict bear markets (which tend to be elusive whenever they are sought by analysts). Instead, I look for signs of early strength in overlooked areas of the market that will likely surprise investors with a strong performance in the months ahead.
Right now, I’m seeing preliminary indications that the largely ignored energy sector could turn the corner in 2025. Specifically, I’m seeing value in coal, oil and natural gas stocks, and especially in companies in those areas that are also transitioning into renewable energy while maintaining a footprint in traditional fuel exploration and production.
The bottom line is that no one knows for sure what next year may bring. But even if we do end up experiencing a bear market at some point, there will always be opportunities to profit on the long side from individual stocks that are poised to emerge from an oversold and undervalued market condition. That’s why turnaround trading and investing never go out of style.
To learn more about the turnaround candidates I like now, subscribe to Cabot Turnaround Letter today.
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