January 23, 2023
As we said in our Year Ahead update in early January, “We might stay open to some dramatic reversals in 2023”. Indeed, investors are witnessing a start to the year that doesn’t fit the consensus view of what should be happening. In short, the markets have been trending up so far in 2023 despite extreme investor pessimism, negative consumer sentiment, dramatic calls for a deep recession, and disastrous earnings warnings. This update will focus on what’s working so far in 2023, separating lasting opportunities from those that could be more fleeting.
Solution Series – Tax Strategy for 2023 and Beyond
First a big thanks to Will Brennan, our Lead Advisor and Certified Financial Planner, for conducting our first Solution Series of the year. It was a well-attended Webcast. Who knew we could be captivated by all the changes in the tax code for a full hour? Will did an excellent job highlighting planning opportunities within the new Secure Act 2.0 tax law, many of which go into effect immediately and many more in 2024. Paying attention to tax saving opportunities can offer you an extremely high return on your time investment. You can find the video of the whole session here .
YTD Scorecard – Bespoke
Let’s start with this big easy score card provided by Bespoke. This is something that I look at every week just to get a feel for what’s happening across sectors, style box investing, global markets, and different asset classes. It’s a good exercise that I would recommend to any who care to know what’s happening in the world of finance.
Let’s dive in to see What’s Working!
Internationals > Domestic
Looking at the top right-hand corner of the score card, we see internationals absolutely crushing our domestic markets YTD with special emphasis on China (+12%), Emerging Markets (+10%), Europe (+8-10%), Australia (+9%) and Mexico (+15%) leading the charge. As regular readers know, we began accumulating positions in internationals in late October of 2022 and brought them to overweight in early December. In October at our annual meeting, we called out the special opportunity here on the basis of historically cheap valuations, a top in interest and lending rates and a top in the US dollar. This is the perfect trifecta environment for internationals. I would add that the clock is ticking on Russia’s invasion of the Ukraine as allied NATO forces add more military and economic pressure to end Putin’s war. European equities are already beginning to price in the end of the war. Oil and Gas prices are now BELOW the prewar levels. This trend has legs for the foreseeable future, but buyers should patiently wait for pullbacks to buy the dips among these new bull markets. We have special preference for high dividend paying internationals, many of which are paying 4-6% annual yields. Leadership among internationals has also been one of our Big Three Investment themes since 2020. However, this trend didn’t really establish itself until late 2022 so we were admittedly early. Now it is game on.
Note on International Bonds – I would have to extend my enthusiasm for internationals to their bond markets as well, especially emerging market bonds which have a current yield of 6.52%, almost twice that of a 10-year US treasury Bond. Yes, these bonds have stated lower credit quality around BBB compared to the US AA+ but, but, but… you have to understand that the rating agencies have a strong US home bias. In the US, our Debt is 135% of our GDP! If we didn’t have a very active printing press, our credit rating would probably be closer to any 3rd world country. For as long as EM bonds are trending up at twice the rate of the S&P 500 and kicking out 6.5% in yield, paid monthly, we’re going to own them. We own these ETFs and funds in our investment strategies: EMB, EMLC, PCY, and PEBIX.
Value > Growth
Also in our Big Three themes is the dominance of the Value over Growth. Thus far in 2023, the theme continues and has not reversed. Looking at the score card above again, we see the following results YTD through 1/20/23:
| Size | Value | Growth |
| Small Caps | +7.25% | +4.40% |
| Mid-Caps | +6.98% | +3.78% |
| Large Caps | +4.10% | +2.94% |
As discussed last year, these style themes tend to last 3-4 years. From the chart below from Fama and French, we see that we’re about two years into the trend favoring Value with potentially another 2-3 years to go if history repeats.
With that said, the most pronounced period of outperformance for value is probably behind us and we would expect to see periods like 2023 where there are only slight differences between the two style groups. If we look under the hood of Value on a YTD performance basis, we see that companies described as “shallow value” are actually underperforming the market, while “deep value” is far outperforming everything. Shallow value represents companies that are only slightly cheaper than the market but still have positive cash flows, healthy balance sheets, steady revenues, and above average dividend payments. 2022 was a good year for these but 2023, not so much. We are actively reducing our exposure to “shallow value” ETFs. “Deep Value” are the bottom 20% of all stocks based on current valuations. These might seem like value traps to many, but this is where the opportunity lies. To own these, we really need to get into stock picking and sift through the value universe for the most discounted and oversold names out there, trading in single digit forward P/Es. Sadly, there are not many index type products outside of specialty “Value” mutual funds that focus on Deep or Pure Value – I’m still looking but haven’t found much. Note – Our Worldwide Sectors strategy is in a magical place as it can be heavily invested in Internationals and own deep value individual stocks through sector exposure. I expect good things from this strategy in 2023 as the performance YTD confirms.
While the Growth style is still out of favor and should be held at minimum exposure, there are some opportunities developing in 2023. This is the first reversal of 2022 patterns. Again, we really need to sift through the wreckage here to find growth names with longer term potential. I won’t name names here to protect our work, but I will offer this advice; Investors should focus on 1-year operating cash flow and Price to Earnings Growth ratio (PEG) as good variables to watch for opportunities in the growth world. Negative operating cash flow? No thanks! PEG ratio over 1, no thanks! As the fire sale in growth is extinguished, we are finding some diamonds among the ashes. Stayed tuned for more on this. Current clients are welcome to look at their Worldwide Sectors’ account holdings where you see a few growth names recently purchased at very deep discounts.
Sectors and Cycles
Let’s shift to sector winners (and losers). This again from Bespoke this am.
Wow, what a reversal of trends from 2022! Communication Services was the worst performer of 2022, now it’s the best with over 80% of underlying stocks trading above the moving average trend. On the flip side, consumer staples, utilities, and healthcare are all some of the worst performers YTD. All three “recession” sectors are down YTD. Broadly speaking, what we are seeing in sector moves does NOT tell a story of deep recession or a recession that isn’t already priced into the market! Sector strength is a leading indicator, and the story so far is about a strong consumer that is fully employed and an economic cycle that is almost emerging from recession! On Thursday, we’ll get a look at GDP, it will be positive. On Friday, we’ll get a look at Core CPI, it will be tame and falling month over month. In February, the Fed will raise interest rates reluctantly by .25% but it is likely to be their last. Frankly, I’ve seen economic environments that are far worse than what I see today. Again, the hardest thing about investing is eliminating assumptions about the future and allowing pure data to show you the true path. Too many are emotionally locked into an outcome that simply may not happen and they will miss tremendous opportunities (as always). I have zero opinions about the future, just watching the data and responding accordingly.
Bonds/ Stocks/ Commodities
Looking through the asset allocation lens we see all three food groups trending up thus far in 2023. What a refreshing change from 2022! Bonds are discounting a future recession and easing inflation. Stocks continue to rise from the lows in October. Commodities are not doing much but still slightly positive suggesting that inflation is not gone yet. Today is a great day to hold a diversified portfolio across different asset classes and a clear opportunity for investors to rebalance their unbalanced positions. If I had to pick an asset class with the most potential in 2023, it would have to be bonds, especially hybrid types like preferred securities, investment grade corporates, high yield corporates and emerging market bonds. It’s not wrong to own your basic Treasury bond as well but there is just a lot more bang for your buck in the lower quality areas now. After a rather bloody 2022, both of our bond income strategies are already having the best starts YTD since 2009; a year in which both strategies generated returns over 20% (not a forecast!).
Commodities have the least opportunity from our view with the exception of precious metals. I do not expect energy to repeat 2022 performance in any way and it would be very surprising to see inflation beneficiaries excel in an economic environment that is somewhat recessionary. Why precious metals? That’s a long discussion but generally Gold and Silver tend to do very well in a falling US dollar world especially as the Federal reserve ends a tightening cycle. We bought gold and silver mining ETFs (RING and GDX) back in September and added to them in October. Precious metal mining companies have outperformed the S&P 500 by 3:1 since October.
There are a lot of opportunities and new bull markets in development now. What a change from 2022 when nearly everything lost double digits or worse. We’ll take it as it comes.
Cheers!
Sam Jones
