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How to Profit Indirectly From a Sector Downturn

Each sector downturn is different and must be analyzed separately. That said, we can use the energy downturn, which started with sliding oil prices in late 2014, as an example to learn how we can profit indirectly from a sector downturn.

An investor could have made lots of money from investing at the lows of the energy downturn. Arguably, at the time, there was a higher risk to invest in energy stocks because they were falling knives — until they weren’t.

It’s very difficult to catch the bottom, but typically, averaging in to a stock over time can lead to a more favourable outcome than going all-in at once.

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To avoid getting whipsawed by the sector in question, it is safer (and still lucrative) to invest in industries that are indirectly affected negatively by the sector in question but are still profitable.

Instead of investing in oil and gas producers and oil and gas equipment and services companies during the energy downturn, investors could have invested and profited from three industries that were dragged down.

Some have already recovered nicely.

Canadian banks

The big Canadian banks underperformed in 2015 and were discounted compared to their normal multiples. At the time, the market was worried about the loan losses in the energy sector.

Fast forward to now: lower oil prices have been accepted as the new norm, and energy companies have positioned themselves to survive or even thrive in this new environment.

Through the downturn, the banks continue to be the most profitable businesses in Canada. As the downturn turned out to be a non-event for the banks, they rallied strongly while continuing their dividend increases.

For example, since 2016, Canadian Imperial Bank of Commerce (TSX:CM)(NYSE:CM) has rallied 27% and increased its dividend by 7.6%.

REITs with Albertan exposure

Investors could also have profited from investing in real estate investment trusts (REITs) which have exposure to resource-based regions but remain fundamentally strong.

Compared to some other peers, Northview Apartment REIT’s (TSX:NVU.UN) funds from operations per unit have remained relatively stable. They only declined 1% and 9%, respectively, in 2015 and 2016.

Further, its residential portfolio ended with an occupancy of just over 90% at the end of 2016. It also maintains a payout ratio of about 77%, which supports a sustainable distribution.

The stock fell below $17 per unit in late 2015. Since then, it has rallied more than 30%. Even after the run-up, Northview still has some runway, especially if oil prices move higher. It also offers a safe yield of 7.3%.

Energy infrastructure companies

Energy infrastructure companies, such as TransCanada Corporation (TSX:TRP)(NYSE:TRP), transport and store energy. Their profitability is less affected by changes in commodity prices.

Still, in late 2015, TransCanada fell below $44 per share. Since then, it has rallied more than 38% as oil prices stabilized. Even after the run-up, TransCanada offers a 4% yield, and it continued to hike its dividend through the downturn and beyond.

Investor takeaway

Next time you see a sector downturn, don’t be hasty and jump in to that sector. Instead, think about which sectors the downturn would affect negatively and look for safer investment opportunities in those sectors.

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