alexsl/iStock via Getty Images As investors have said a relieved goodbye to 2022, where we saw high inflation, market volatility, supply chain shocks, labor market shifts, and interest rate hikes, what can stock pickers look forward to in 2023? To help us answer that question, host Oscar Pulido welcomes back a Bid regular, BlackRock’s CIO of US Fundamental Equities, Tony DeSpirito. Transcript Oscar: Welcome to The Bid where we break down what’s happening in the markets and explore the forces changing the economy and finance. I’m your host, Oscar Pulido. 2022 was certainly a year to forget as far as investing goes. We saw record-high inflation, market volatility, supply chain shocks, labor market shifts, and interest rate hikes. So, as we turn the page in a new year, what does 2023 have in stock for investors. To help answer that question today, I welcome back a Bid regular BlackRock’s CIO of US Fundamental Equities, Tony DiSpirito. Tony, welcome back, and thank you for joining us on The Bid. Tony: Oscar, thanks for having me. I look forward to our discussion today. Oscar: Let’s start with the fact that 2022 was a tough year for stocks. It was the worst year since the global financial crisis back in, in 2008. But if that weren’t enough, it was also a bad year for bonds. So, investors suffered both in their stock portfolio and their bond portfolio. So, you know, you’ve been in an investor for a while. This was an unusual year. What takeaways do you have from 2022 and maybe help us look ahead to 2023? Tony: Sure. Yeah. As you point out, I think what was most unique about it was the fact that both stocks and bonds were down a lot, and that really makes it historically unique. We haven’t seen anything like that in a really long time. When I think about the lessons learned from 2022, I think the biggest lesson is valuations matter. And that’s true for both stocks and bonds. On the downside, high rich valuations are risk. Certainly, growth investors felt that. And on the other side, low valuations can provide a margin of safety, and that’s why value did so well on a relative basis. When I look forward for 2023, I think valuations are much more normalized today than they were a year ago. And so, I really think there’s an opportunity for barbelling both value and growth in investor portfolios. Oscar: One thing that dominated the headlines last year was inflation, what the Federal Reserve was doing in terms of increasing interest rates to try and combat that higher inflation. Should we expect more of that in 2023? Or where do you think we are in that cycle of inflation and the Fed dominating the headlines? Tony: I definitely think inflation is peaked, for the cycle. The Fed has done a lot of heavy lifting. We’ve had the steepest series of rate increases in the last 40 years, not to mention, add in quantitative tightening. So, the fed’s done a lot, and when you think about inflation, the components, goods, housing, core services, definitely goods and housing that has rolled over. Core services will be a little bit more sticky. But I see that coming down as well, just more slowly. But when you think about long-term, there’s still the long-term drivers of inflation are still there, so I don’t think we’re going to go back to those ultra-low levels of inflation that we saw post-global financial crisis over the last decade, we’ll likely see something a little bit higher. And whether that’s because of de-globalization and reshoring or just demographics, the aging of our societies globally, or decarbonization, all these forces are going to put a little bit of pressure under inflation. So, I see it coming down cyclically, but I see long-term, there’s being some structural drivers that’ll make it higher than what we’re used to. Oscar: Right, so inflation is peaked, I think is what you said, but it’s going to settle at levels, at least, maybe the percentage increases in inflation will be still higher than what we grew accustomed to for much of the last 20 or 30 years. Tony: Exactly. That’s exactly what I would expect. Oscar: And another word that maybe wasn’t so much dominant last year, but started to appear more as the year went on, and now here in 2023 is the word recession. And are we in one? Is it coming? How do you think about the recession and maybe the impact on the stock market? Tony: Yeah. So, our colleagues in the BlackRock Investment Institute are fond of saying this is a recession foretold. And I do think this is the most predicted recession that I’ve ever seen, certainly, in my career. And, when you think about the telltale symptoms of a looming recession, they’re there. Fed tightening, for example, in 10 of the last 13 Fed tightenings have resulted in a recession, we see the yield curve, it’s inverted. That’s a classic predictor of a recession. And then, if you look at fed activity it happens with long invariable lags, the Investment Institute sort of sees that peaking, those effects peaking in the third quarter of this year. And then I would add, in terms of consumption trends, if you think about what happened with consumers, they saved a lot of money during the pandemic. A combination of greater government aid plus, there were fewer things to spend on, that meant consumers built up their balance sheets, they built up saving. Well, they’re now working off those savings. And that’s stimulative in the short run. But this can’t go on forever and very likely we’re going to start to see that slow as the year progresses. So, I do think there’s a high likelihood of recession. That said, it’s important to keep in mind the size, the depth, and the duration. I don’t think this is going to be a big, bad recession. Muscle memory leads you back to 2008. I don’t think this looks anything like 2008. 2008 was once in an eighty, once in a hundred-year kind of event. I don’t see those kinds of excesses, so I would expect something much more mild and moderate. And therefore, the impact on earnings and the impact on the stock market should be more modest as well. Oscar: And I was going to actually ask about company earnings. You painted a little bit more cautionary tale around the economy but acknowledging you don’t think it’ll be as deep as what we saw during the financial crisis, but now the next impact is what does it do to earnings? I don’t think company earnings have suffered really just yet. Is that coming? and how do you then think about that when you’re a stock market investor? Tony: Yeah, so I, I think in terms of earnings, the outlook is more dicey. Certainly, post Covid, we had some really robust series of earnings growth that’s not going to repeat. And since the back half of last year, we’ve started to see earnings estimates trickle down. There’s probably still some more to go. So, I don’t see a lot of beta from the market, but I do see a lot of opportunity for us as stock pickers to really look for companies where maybe recession’s already priced in, for example. And you could actually have upside once the reality sets in, you actually could see stock prices rise. I think there are also some companies where their earnings power is going to prove to be more resilient. And it’s not priced in. I think that’s also an opportunity. So, I do see whether it’s because of dispersion in earnings estimates or dispersion in valuations, real opportunities, for stock pickers over the next 12 months. Oscar: Is there such a thing as a recession-proof portfolio? I don’t know, that might be a bit of a holy grail, but I imagine maybe something that, that you get asked about now or you will get asked if we do see a recession. Presumably, it doesn’t mean abandon the stock market altogether, where do you try and find those pockets of resiliency, maybe to use the word you used? Tony: Yeah, I think resiliency is the right word. There’s no equity portfolio that’s recession-proof. If you want recession-proof, you should be invested in treasuries. That said, to your point, you can certainly make your equity portfolio more recession resilient. In the portfolios I run, my largest sector overweight is healthcare. I think it’s an attractive sector from a long-term growth point of view. Historically, the earnings in the healthcare sector have proven to be very recession resilient. I see no reason why that won’t happen in the next recession. And then I look at valuations, and here’s the trick. Many of those more resilient sectors have been bid up in price, whether it’s staples or utilities, et cetera. Whereas healthcare, on average, healthcare is trading at a below-market multiple. And so, it doesn’t mean just buy the sector, wholesale, but what it tells me is there’s a lot of opportunity. It’s a fertile ground for stock pickers. Oscar: You started to talk about sectors and healthcare as an area to look for opportunity in a softer economy. Can we talk about energy, which, as bad as the market was last year, globally, we talked about not only in stocks but in bonds, energy was this bright spot. So, do you think energy continues to outperform in a year like 2023? Tony: I think it can, I do think energy stocks are still attractive. It comes down to supply and demand. Demand is still quite strong, particularly in the near term as we see China reopen, that’s going to be a driver of positive demand. That means higher oil prices. On the flip side, supply has been extremely constrained. Energy companies went through a deep recession back in 2014 and they have been constrained on investment in new discoveries, investments in new developments. That means higher oil prices. So you combine the supply and the demand pitcher together, the outlook is actually pretty good for energy. I do think there’s a lot of opportunity again for stock picking. One of the big dislocations that we’re seeing is between US integrateds and European integrated. They both trade at low multiples, but the European integrateds are trading at half the multiples of the US integrateds despite having fairly similar business models. I think that’s a real opportunity. Oscar: We were actually talking a little bit before we kicked off here. You were sharing some viewpoints geographically. I know a lot of your focus is in the US, but just since you mentioned European integrated oil companies seeming more attractive than the US, is there a geographic lens that you would put on the stock market in terms of rank order where you see better opportunities or are they all in the US or are there some markets outside the US that are starting to look more appealing? Tony: I do see opportunities globally. I think the US — what’s great about the US is one, we have some of the best companies in the world. So, when you think about quality of business, US wins hands down. Also, in terms of earnings resiliency, it’s easier for US companies to adapt to a slow, demand environment or recession. That’s just the way it works in the US. Those are the two positives I see for the US. In terms of international stocks, they have valuations in their favor. The US is the most expensive market. And so, from a valuation point of view, that’s where I see opportunities outside the US. And it’s just a tradeoff, quality versus valuation. Oscar: Got it. So maybe let’s go back to sectors for a second. You talked about healthcare, you talked about energy. Technology, you said this at the very beginning, growth as a style of investing lagged last year, technology was at the forefront of that. So again, we’re going into 2023, how do you see the technology in those more growth-oriented sectors doing? Tony: Yeah, so there was a big valuation derating in 2022. In fact, to the point now when you look at valuations for growth stocks broadly, certainly including technology, those valuations, those relative multiples are now back to historical averages. I don’t think that there’s a lot of valuation risk left in growth stocks or in technology. So then it really comes down to the earnings growth. Now demand for parts of tech is a little bit light, corporations are pulling back. A lot of CEOs, CFOs are worried about a potential recession that causes them to be a little bit more constrained when it comes to spending on technology. So, we are seeing a little bit of demand softening. That said, we’re seeing companies with very resilient business models. We’re seeing, if you look at cost-cutting, tech is the area where we’re seeing the most cost-cutting and that’s — an industry or a sector where there is, for lack of a better word, a lot of fat, I think that you’ll see the earnings power hold up pretty well. So, I do think technology investments can be really good for 2023. In fact, I run value portfolios, and I mentioned that healthcare is our largest overweight, tech is our second largest overweight. I think that really tells you where valuations have come. Oscar: And it goes back to what you said at the beginning, valuations matter. It seemed like last year, the headlines were also dominated by events that were going on at a very macro level. The war between Russia and Ukraine, the Fed tightening, very macroeconomic type events. And you’ve mentioned a couple of times, if you look at individual companies, there’s opportunities. Can you remember an environment that was either similar to this or is this a unique environment where what you’re seeing at the company level is more interesting and, being missed by the headlines that tend to be more dominated by what’s going on just from a policy and a geopolitical perspective? Tony: I think we saw peak macro in 2022. And that doesn’t mean the macro’s not going to be important. It is. But I think we’re going to see much more emphasis placed on individual stock picking, much more emphasis placed on what’s happening to this company. How is this company, this particular company, dealing with a slowdown in the economy, does it have pricing power? In 2022, with inflation, every company had pricing power effectively. That’s the definition of inflation. In 2023, I think pricing power is going to be more selective. A company’s ability to respond to a slow demand environment, all this tells me selectivity is going to be key. And that’s where stock picking comes in. Oscar: So lastly, Tony, with a New Year comes resolutions for 2023, if you were to give investors an investment-related resolution for 2023, what would it be? Tony: When you ask that question, I immediately think of an ex-colleague of mine who had a sign on his desk. Patience equals profits. I think that’s great wisdom for any investor, particularly in a time like now where volatility’s high. When volatility is high investors tend to get more shortsighted, and that’s a mistake. Investors of all stripes, whether you’re an asset allocator or a stock picker, I think investors, in general, do better when they take that long-term patient perspective. Oscar: That’s a great resolution. Patience equals profits is the line that hopefully people will remember. Tony, thanks again for joining us on the bid. Tony: Thank you, Oscar. My pleasure. Sources: https://www.cnbc.com/2022/12/29/stock-market-futures-open-to-close-news.html Treasury Yield Curve Reaches Steepest Inversion in 40 Years This post originally appeared on the iShares Market Insights. Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
