tdub303
Dear subscribers,
2022 was a very interesting year. While I ended the year solidly in the green, most of the investors I speak to did not – and there is certainly no shame in that, given what sort of year we had and where most people were positioned in terms of their portfolio allocation.
Nor am I claiming that I expertly allocated my funds to exactly the right sectors during the year – such a claim would be flawed. I had exposure to sectors that saw some significant declines as well, even if I managed to score some incredible winners with 50-90% RoR during a very difficult year.
However, 2022 is now over.
It’s time for 2023.
What does 2023 mean?
2023 means, to me, that we need to consider the following:
- Inflation is still high, and the central banks are far from being done with rate hikes. At some point, it’s likely that we will see a slowing in hikes, due to the impact on economic growth and inflation being under control.
- However, this is a far step removed from actually reversing the direction of the rate policy. I believe we will be in a higher interest rate environment for some time, and before any significant lowering of the interest rate is done, policymakers are very likely to look at exactly what even a 25 bps reduction will do to inflation, unemployment, and other core factors.
- 2022 is shaping up to be one of the worst years in a long time for tech or growth-oriented portfolios – and even conservative 60/40 portfolios have mostly been either performing badly or underperforming. I don’t see that necessarily changing for 2023, depending on where you’re allocating.
- I don’t see a reduction in inflation being enough for any central bank to start lowering rates in the near term. I believe this is wishful thinking – and in my case, I don’t hope for it. I, in fact, hope for the central banks to keep pushing the interest rates, as I believe the global economies do need it.
- The global economic macro may face headwinds due to the strong state of the US currency, due to most transactions being dollar-denominated. This means that the costs of doing business are more expensive for non-US companies.
- This doesn’t just affect companies – I myself trade denominated in SEK – the dollar is up to 10.50 and has been for some time. It’s great for incoming dividends, but only 10-20% of my current cash goes to USD due to this, compared to 85-90% only 2 years ago. Instead, I invest in SEK, NOK, DKK, GBP, and JPY. This is made easier with IB, which allows for full Forex control.
- The central bank of England and Japan has already had to step in once during 4Q22 to stabilize their currencies – In Japan’s case, a decline in the value of the Yen, in England due to its bond market and pension system. The ripples of financial instability are spreading, but are, as of now, seemingly under control.
- The general stance from most macro analysts I follow is that increased financial instability in 2023 is unlikely – but preparation anyway is always prudent.
- China is slowing down. There is a collapsing property sector, and now-lifted COVID-19 restrictions, a complete reversal that has caused European nations to impose travel restrictions on Chinese travelers. The Chinese property sector is likely to continue to fall, with a compressed construction sector affecting companies worldwide. The focus out of Beijing is stability, not stimulus. Keep in mind that China is determined by the U.S. treasury department to be a Currency manipulator – so anything out of this nation should be viewed and calculated with extreme caution. I am currently 0% China, with no change planned.
- Dividends are likely to remain appealing. With most quality companies offsetting cost increases through pricing, I don’t believe we’ll see many major dividend cut across the A-list in most countries.
That, more or less, are some of the major things currently on my mind for the coming year – certainly not all though. Europe seems to be the first at risk of a recession, the UK after, and the US in third place. Emerging markets are especially vulnerable to USD FX, which means that risky investments outside of the western world are going to take a backseat for me as well.
Sweden is according to most forecasts, also likely to go into recession this year, even if only slightly.
All in all, it’s a challenging market, but here are the sectors I favor and the various reasons I do favor them.
These are in no particular order – the appeal is based on individual companies, not sectors alone.
1. Telecommunications
2022 was a challenge (and opportunity) for Telco, with most Telco facing declines due to pricing competition, margins, and cost increases. Profitability is the battle cry for these companies, as it should be. Out of my holdings, only 2, among them Deutsche Telekom (OTCQX:DTEGY) was solid for the year, with most others in the red.
However, I view this as a completely illogical and temporary development, due to the macro backdrop in this sector. In the US alone, The IIJA in November of -22 allots $65B for broadband adoption and deployment, and the global telco market is expected to almost double by 2030, with a CAGR of 6.9% from 2022-2030.
The yield and the respective qualities of the businesses therein means that I am not worried in the least, and I keep this among my largest sectors. Each company has its specific margin challenges, and I focus on investing in market leaders with solid positioning that can weather storms, as opposed to emerging market risk plays.
Furthermore, the valuation for most of these is currently incredibly compressed, making for a very attractive case.
Here are some currently undervalued companies I look at in the sector:
- Verizon Communications (VZ)
- AT&T (T)
- Telenor (OTCPK:TELNY)
- Deutsche Telekom/T-Mobile (TMUS)
- Vodafone (VOD)
2. Finance/Banks
Banks are likely to outperform for a number of reasons. First off, credit growth is still expected and reported to be robust. Secondly, anything tied to NII or NIMs (interest-related incomes and margins) is likely to outperform given the rises in interest rates. Third, likely increases in PPoP (pre-provision Op. profit), with continued solid traction in fee income as well as treasury and bond income. The only headwinds here are funding costs – but the fact is, most banks that I invest in are reporting absolutely stellar numbers.
Banks are in nowhere near the position that they were in 2008. Now most of them have absolutely stellar sheets that will allow them to outperform in this environment. That is why I remain heavy in banks and financials.
Insurance companies and reinsurance plays, while not completely the same, share some of the characteristics here, and I believe several of them will, and already have outperformed in 2022.
By the way, this also means Business service companies and credit card companies in the financial sector, such as Visa (V).
Here are some currently undervalued companies I look at in the sector:
- Citigroup (C)
- Blackstone (BX)
- Allianz (OTCPK:ALIZY)
- Munich Re (OTCPK:MURGY)
- Scotiabank (BNS)
3. Consumer Staples
Current stabilization in inflation rates will impact real income development, which in turn will support the staple companies. The ongoing recovery in most sectors such as retail, tourism, transportation, and hospitality will drive spending on staples and low-end as well as potentially high-end discretionary spending. A current expectation is for a faster-than-expected recovery in European households that are categorized as “low income.”
Staples have a tendency to be better than metastable – and they outperform in most markets. that is why a considerable portion of my capital is allocated to staples such as food, hygiene, and similar products, including exactly low-end discretionaries.
Here are some currently undervalued companies I look at in the sector:
- Ahold Delhaize (OTCQX:ADRNY)
- Coca-Cola Consolidated (COKE)
- Keurig Dr Pepper (KDP)
- International Flavors & Fragrances (IFF)
- Altria (MO)
- British American Tobacco (BTI)
4. REITs/Real estate
I believe REITs are positioned to generate outsized performance for 2023 and forward. Valuation for the average REITs, especially in certain sectors, has seen absolute destruction in 2022. BBB+ and A-rated companies are trading as though they’re going out of business.
While some will argue term premium risk and the way REITs, especially certain sectors are exposed to the ups and downs of the broader economic cycle, the facts are:
- REITs have traditionally outperformed even during periods of rising interest rates.
- It remains a location and valuation-oriented play, with a focus on the quality of assets, gearing/debt.
- Despite fears, the cost of debt, cost of equity, and opportunity cost increases hurt Tech/growth-oriented companies far more than it does REITs, due to the floating nature of ROIC in most sectors (Tech, for the most part, does not have a floating ROIC). This is not unique to REITs, but it’s a good example of this.
- The cash flows from many REIT subsectors, such as self-storage and apartments, are made exactly to resist downturns such as the ones we’re seeing.
However, important to remember is that not all REITs or REIT subsectors are created equal. Because of this, picking which of the companies you invest in is very crucial.
That’s where analysts such as the ones on iREIT on Alpha/Dividend Kings come in.
Here are some currently undervalued companies I look at in the sector:
- AvalonBay Communities (AVB)
- Essex Properties Trust (ESS)
- VICI Properties (VICI)
- Vonovia (OTCPK:VONOY)
- Kilroy Realty (KRC)
- Highwoods Properties (HIW)
- Boston Properties (BXP)
- Digital Realty Trust (DLR)
- National Storage Affiliates (NSA)
- Public Storage (PSA)
5. Utilities
Utilities are a generally strong play for their safe and conservative (usually) pay-out of dividends based on cash flows that come from regulated sources with high transparency and forecastability. That’s why I, for instance, own 5.1% in Enel (OTCPK:ENLAY). Utilities, whether electricity, water, or other, similar plays remain an attractive sector with a very strong outlook.
This is due to the defensive characteristics of this sector which make them essentially a safe haven during a storm like the one that’s brewing here.
However, that is not all.
The long-term growth potential of this segment due to the global shift from petrochemical energy to electrostate may very well provide a realistic, long-term tailwind that could combine a shelter for you with long-term growth potential and conservative appeal. Almost all utilities are playing the renewable game – it’s a matter of 5-15 years until we’re in a very different place, and I believe utilities are one of the primary beneficiaries of this trend.
Utilities already had a pretty good 2022 for the same reason I mentioned here. They outperformed the S&P500 by nearly 15% for 2022, just as an entire segment.
I continue to see the overall importance in utilities and continue to forage for the “best” in this segment.
Here are some currently undervalued companies I look at in the sector:
- Enel (OTCPK:ENLAY)
- Algonquin Power (AQN)
- E.ON (OTCPK:EONGY)
- Fortum (OTCPK:FOJCF)
6. (Key) Industrials
Following decades of underinvestment in capacity and infrastructure in Europe as well as the US, I believe that Industrials and manufacturing continue to be poised for a very strong long-term trend. Industrials are perhaps the trickiest sector I look at because here it’s truly “individual” in terms of what companies to go for.
I believe the trend to be favorable to quality, key EU/NA players because domestic manufacturing (as opposed to Asian) is being sought across many geographies. The recession’s impact on the entire sector was heavy, but this is mostly short-term, which provides more opportunity to me than it does worry.
While global supply chains will in no way disappear, I believe the dynamics at play during the COVID-19 pandemic and what followed (including Russia invading Ukraine) have highlighted to most countries the importance of self-sufficiency and domestic industrial output.
The long-term implications for the sector because of this are incredibly positive, as I see it. That is why I have established large positions in European as well as American industrial companies and will continue to grow these as valuations and trends allow me to do so.
Short-term, this sector is driven by the worries of inflation (costs), interest rates, and supply chain issues. Keep in mind, industrials actually beat the broader S&P500 by 10% last year as a sector.
I believe key industrials are poised to outperform more, and that’s why I’m investing more.
Here are some currently undervalued companies I look at in the sector:
- KION Group (OTCPK:KIGRY)
- Porsche/VW (OTCPK:POAHY) (OTCPK:VWAGY)
- Stanley Black & Decker (SWK)
- Stellantis (STLA)
- Airbus (OTCPK:EADSY)
- 3M Company (MMM)
- BAE Systems (OTCPK:BAESY)
Wrapping up
These are some of the sectors I’m watching and am particularly interested in.
However, I want to clarify that not everything in these sectors is attractive. It’s all about picking the right companies at the right valuation. That’s what I, as a conservative value investor, contributor, and financial analyst attempt to do. Given my 5-year track record, I feel that this is something I do passably well (beaten the S&P500 during that timeframe). We all have our winners and our losers, but I certainly have more green than red during my time, and the companies that are currently in the red are not businesses that worry me for being in the red.
2023 is shaping up to be a very interesting year – and we seem to be starting that year with a day in the red, which honestly is mostly in accordance with my wishes for being able to invest at low valuations at great companies.
One of the major questions for the year seems to be whether we go into a recession, and one of the questions I often get from subscribers, followers, and readers is if I believe this to be the case.
Yes, I do – I believe there will be a recession in 2023.
I believe Europe, in a broader sense, will be in one. I also believe Sweden will enter one. I also expect that it’s possible that the USA might enter one in 2023 due to a combination of hawkish monetary policies, money growth slowdowns, global economic slowdown, and compression. However, as I see it, this will create important investment potentials and inflection points for investors over the next 1-12 months.
I’m not worried about a recession – they come and go like the tide – it’s a part of the system. I have a plan to handle them, as I believe you should.
I will post a second article after this one with Sectors I intend to avoid for 2023 (generally speaking) -so be sure to check that one out as well!
Questions about this one?
Let me know!