tortoon
Stock markets are getting comfortable with the soft-landing narrative. For four months the S&P 500 has been recovering. U.S. stocks were up 15% over the period, but softened over the last week. The bond market has also been recovering for several weeks. The stock market recovery is signalling (or guessing) that any economic weakness will not be ‘too bad’. The bond market recovery is suggesting that inflation has peaked, will decline, and that the Fed will cut rates in the not-too-distant future. How to position your portfolio for 2023 – read on.
To tame inflation we need to get to a recession, or at least much weaker economic growth or stagnation. A slowing economy should reduce demand and thereby relieve pressure on inflation. The question is just how big a downturn will it take to get inflation under control?
Investors are currently suggesting that (at worst) only a mild recession will be required to get the job done. Or course we can’t assume the market makers are right. As I often write, we don’t know what we will get.
BlackRock goes deep on the recession
The team at BlackRock Inc. is not so sure. Taming inflation in the U.S. is likely to require a deep recession, they argue in a recent outlook. If the Federal Reserve is truly intent on grinding inflation all the way back to 2 per cent, it has no choice but to deal “a significant blow to the economy,” they say.
In the Globe & Mail, Ian McGugan suggested …
It isn’t clear how this tension will be resolved. Maybe the economy is truly in a new place and inflation will fade away of its own accord. Or maybe central banks will ease up once inflation falls below, say, 4 per cent. Or maybe policy makers will accept no compromises and endure a painful recession to hit their 2-per-cent inflation target.
We might be open to alternative scenarios to the soft-landing narrative. And my favourite line (from me) is …
Inflation is driving the bus and the Fed is strapped in, on that bus.
Up and down and up – the yoyo call
Deutsche Bank, for instance, sees the current rally continuing over the next few months, driving the S&P 500 to a high of around 4,500 from its current level around 4,050. The bank then sees stocks plunging by roughly a quarter as recession bites, pulling the index down to 3,250 in the third quarter. Policy makers should finally relent at that point and start chopping rates. This should allow the index to recover to 4,500 by year-end 2023, Deutsche Bank says.
The yoyo call is quite common. I see many portfolio managers who predict market weakness in the first half of 2023 and recovery in the second half of 2023.
Bank of America predicted a volatile year for Wall Street in 2023, with the S&P 500 potentially plunging about 25% from current levels in the first half, with a snapback possible later in the year.
In a note to clients, the firm added that this environment puts a premium on high-quality stocks, with BofA highlighting names like Kroger (KR) and Lowe’s (LOW).
From Scotiabank via Scott Barlow
“We see limited equity gains for the year from current levels, especially in the U.S. where the S&P 500 continues to trade at a large premium to its long run average and global peers. While that may sound discouraging after a tumultuous year, we suggest being tactical: opportunities on the long side should arise in the first half, providing an entry point that offers more-appealing upside potential for the long run … [The ten themes are] from inflationary to recessionary concerns, Monetary policy takes another 180 degree turn, Looking for an entry point, From price inflation to wage inflation: No relief for profit margins, Limited equity gains, but valuation rebounds (ex-U.S.), Keep adding serial divvy growers to your portfolio, USD: What goes up must go down, Style Investing: QARP before moving back into Value, Size: Go small or go home, Energy: Secular bull despite short-term volatility”
(Scott Barlow is the Market Strategist for the Globe & Mail).
A different investment landscape
Yes, it’s obvious that we’re not in Kansas anymore. Here is a fantastic post from Fear & Greed Trader on Seeking Alpha.
Week On Wall Street: Very Different Investment Landscape
We are in a new paradigm. And we don’t know where we will land. Economic forces are swirling and intermingling. That post does a very good job of breaking things down, piece by piece, and then takes a look at how events might fit together.
One of the main themes is that inflation might outstay its welcome, and in turn so will higher rates. Any bear market might also be sticky.
The biggest inflation components, energy costs, wages, and rents, aren’t going to moderate fast enough to get prices anywhere near the Fed’s preferred 2% target. If last June marked the peak for inflation, it would be the first time in the past six periods of high inflation (dating to 1969) that inflation peaked (if it has) during an economic expansion. Other peaks came during recessions.
The inverted yield curve call
As John Mauldin writes and shows in The economy is a changin’ – the inverted yield curve has predicted 7 of the last 7 recessions. That’s a good record. Of course we have an exaggerated inverted yield curve in late 2022. A recession is not a given, but it looks likely. The question may be how deep or shallow is any recession that we might get.
Also, the market bottom in any rate hike inspired correction usually comes after the pivot.
Cash flow from Lance Roberts
In this recent post – The lessons from the “Nifty Fifty” Lance offered on the cashflow and dividend theme …
Most importantly, investors should begin to prioritize companies that have, and continue to have, strong balance sheets, resilient cash flows, and high levels of visibility into future growth. Companies with solid business models and a focus on shareholder stewardship (read dividends) will play a more critical role than companies with outsized future growth promises.
What’s working might keep working
On valuation for U.S. stocks, Lance tweeted …
Essentially, the investment theme of what has worked in 2022 might continue in 2023. Good companies with low or modest debt and generous amounts of free cash flow. And yes, getting paid (dividends) will be important as well.
Soft earnings not priced in
The market may be pricing in some form of soft landing, but it is not pricing in the earnings affect thanks to economic weakness. Earnings estimates should come down. In Rates And The Dollar Are Sending Warning Signs, from Mott Capital Management, you’ll see a few charts that support that notion – including an ISM vs EPS chart.
The stock market is pricing in a soft landing of some sort, even a soft recession perhaps. Could be right, could be wrong.
But even if the markets are ‘right’ it is not pricing in softer earnings or an earning recession. So best case scenario might be very low returns or negative but not devastating returns for a year or more? U.S. stocks (the market) are likely still too expensive.
Here’s a post with rate hike scenarios and earnings implications.
Countdown begins to Fed’s last meeting of 2022: What to know this week
Earnings estimates have been coming down. More economic and earnings softness will likely be reported when companies deliver Q4 numbers and guidance. Market pricing might take notice.
In a Wall Street Journal piece, the Dow shines as higher rates squeeze tech stocks.
“If you believe that interest rates are going to stay higher for longer, then this environment where value beats growth is likely to continue,” said Bob Doll, chief investment officer at Crossmark Global Investments. He said his firm is looking to add to its holdings in energy, healthcare and financial stocks.
Bonds are back
Here are some very interesting observations on bond and more thanks to The Humble Dollar blog – New Rules For Success. Bonds have been looking much more sensible over the last few months, but don’t wait too long offers that post. We might accumulate a core of short-term bonds and ETFs and also add some longer dated bonds to take advantage of any recession, and rate cut environment.
On stocks that post (and Jonathan Clements) offers …
What about growth stocks? Their potential for hefty corporate earnings down the road now seems like a more distant promise—and one that might be broken. By contrast, value stocks, with their healthy current earnings and often high dividend yields, have become far more appealing. After all, why speculate on the future when you can collect a handsome dividend check today?
Yes, we’re back to that value theme. Essentially, we might simplify that to say – buy good companies and make a lot of money. It ain’t rocket surgery as I like to say as I mangle “sayings”.
I also included the rebirth of bonds in my MoneySense weekly post. That column makes sense of the week. In Canada we experienced another 50 bps rate hike on Wednesday.
The energy trade remains the same
In October of 2020 I suggested that readers take a look at the Canadian oil and gas stocks. To quote Led Zeppelin – the song remains the same.
The sub sector is the source of the greatest free cash flow in the market. That free cash flow is returned to investors by way of share buybacks and dividends. Any weakness in the sector is an investment opportunity, IMHO.
Let Buffett be greedy for you
Warren Buffett is sitting on $100 billion in cash. He’s licking his chops in between swigs of Coke (KO) and waiting for a real market downturn. In addition to being the world’s greatest investor, he’s a very patient guy. As I wrote in March of 2020, you can invest like Warren Buffett, or you can invest with Warren Buffett – buy Berkshire Hathaway (BRK.B).
Seeking Alpha authors, Wall Street and the Seeking Alpha Quant modelling all love Berkshire today. The stock can obviously perform well enough when stock markets have the all clear signal. But it is when we move through periods of disruption, bear markets and recessions when Warren Buffett and his team will shine. While most investors are gun shy, Mr. Buffett likes to take out his elephant gun (his phrasing) and go hunting for the big deals.
Owning Berkshire Hathaway is an instant cash allocation – in good hands.
Retail investors and fund managers are catching on. In anticipation of a recession (of some sort) investors have been piling into Berkshire. The stock is up 6.5% in 2022 while the S&P 500 (IVV) is down over 13%, even after the recent 4 month old rally.
Look for and find value
One can look for value. There is some value in the U.S., here and there. It’s much easier to find up north here in Canada. Many are happy to take the big dividends and low PEs and wait. There are much better PE ratios and dividends for International stocks (EFA), (EEM) and markets as well.
Morgan Stanley’s Mike Wilson cautions that the market rally may have run out of legs. He offers …
This makes the risk-reward of playing for more upside quite poor at this point, and we are now sellers again.
Investors should stick to defensive sectors – Utilities (XLU), Healthcare (XLV) and Consumer Staples (XLP) – with rates falling further into the next as growth and inflation slow more.
Cash in hand for retirees
For retirees, a certain amount of cash in hand might be key. As many would say – “cash flow rules”. With spending needs covered (or mostly covered) by portfolio income, we reduce the sequence of returns risk. We don’t have to sell meaningful amounts of stocks as markets and prices decline.
You can slant to the healthcare sector with your REIT selection as was offered by Brad Thomas.
3 Ridiculously Cheap REITs That Scream Buy, Buy, Buy
Keep on keepin’ on
I am comfortable staying the course. I have been in Canadian high dividend (value/profitability) with an energy bolt on. That combo at 90/10 weighting has delivered 40% in 2021 and 10.2% in 2021. What inflation effect? Not in my portfolio.
Here is a post detailing our Canadian and U.S. portfolio holdings.
Our U.S. stocks have beat the market and offer less drawdown in market corrections. In 2015 I skimmed 15 of the largest cap dividend achievers (VIG) that work in tandem with 3 picks – Apple (AAPL), BlackRock (BLK) and Berkshire Hathaway.
Dividend ETF front
But given that I like energy exposure, I’ve been more of a fan of the Vanguard High Dividend Yield ETF (VYM) over the last year and more. Of course, a favourite with Seeking Alpha dividend investors is Schwab’s (SCHD). I prefer VYM for the sector allocation. Do your own research and come to your own conclusion. Read. Decide. Invest.
Stocks I like in 2023
Stocks I could buy all day long include anything in my Canadian Wide Moat Portfolio. In the U.S. and on the defensive front, I’ll be happy to add to Lowe’s (LOW), Walmart (WMT), Kroger, Colgate-Palmolive (CL), CVS Health (CVS), PepsiCo (PEP), Raytheon (RTX), Stryker (SYK), and Berkshire Hathaway.
And of course, buying stocks at much lower prices is great. If there is a real correction and if reasonable valuation shows up, I’d be thrilled to add to growthy assets such as Apple, BlackRock, Texas Instruments (TXN), NIKE (NKE), QUALCOMM (QCOM), and to also build positions in Alphabet (GOOG) and Tesla (TSLA).
I will continue adding to my oil and gas stocks. In my retirement account (called an RRSP in Canada) I have an 11% weighting to oil and gas stocks, not including the pipelines. So, I might be getting near a reasonable allocation.
I’ll chip away (very modestly) at Bitcoin (BTC-USD) and Ethereum (ETH-USD) and my “green” exposure in green metals (GMET) and the Amplify ETF (BATT) that invests in the electric vehicle and battery ecosystem.
Sector arrangement might also continue to be key
For those who are retired or in the retirement risk zone, they might consider the all-weather portfolio models.
On Seeking Alpha I recently post on the all-weather stock portfolio for retirees. While the traditional all-weather portfolio will employ cash and bonds and commodities in addition to stock and REITs, we can also arrange stocks that will potentially perform well in periods of inflation and deflation that coincide with economic growth or economic decline scenarios.
2023 investment summary
If you’re in retirement, preparing for retirement, or seek a lower risk portfolio, you might play more defense with consumer staples, healthcare, utilities (including pipelines and telcos) at the core. When you venture outside of team defense, pay attention to quality and free cash flow.
Bonds and cash can be a useful store of value that will protect your near-term spending needs. That might also provide a rebalancing opportunity in 2023.
Those in the accumulation stage with a high tolerance for risk might ignore all of the above. Add monies on a regular schedule; stick to your investment plan. The risks are different in accumulation, and market timing is impossible. That said, I still like the idea of avoiding any outrageous over-valuation.
I am not cutting loose my dedicated inflation protection (DBC), (IYE).
Best of luck, happy holidays, and I too hope we tame inflation and get some form of soft landing that limits the financial hardship for families in North America and around the globe.
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Dale
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