John Zechner, chairman and founder, J. Zechner Associates

MARKET OUTLOOK:

Interest rates remaining “higher for longer” as well as earnings are the biggest risks for stocks in 2023, much as rising interest rates were the biggest risk last year. The economic data has remained robust, but aggressive rate hikes have yet to show up fully in the economic numbers, primarily because the economy had a lot of momentum going into the rate-hiking period. Business inventories were low and consumers were still relatively flush with cash from all the stimulus offered during the heights of the pandemic. Higher interest rates are taking their toll on housing, auto sales and other interest-sensitive sectors. This is spreading to other sectors of the economy as consumers and businesses roll over existing debts at much higher rates. It is not a matter of “if the slowdown will occur,” it’s only a matter of “when.”

So how do we factor also this outlook into a cohesive, low-risk strategy for investing in 2023? Our simplest call is to increase exposure in bonds to at least a market weight (40 per cent for most balanced portfolios). Cash returns have risen and we prefer holding cash over preferred shares at this time since we still see some credit risk from the preferred share sector as economic growth slows. In terms of stocks, it is more of a conundrum. Markets rarely suffer two negative years in succession, so last year’s poor returns may already incorporate much of the bad economic news we see ahead. 

After January’s rally, we have moved back to an underweight position in stocks (40 per cent in balanced funds, at the low end of our traditional 40-60 per cent range). We reduced technology stock exposure as we want to see how the economic slowdown will impact some of the key growth areas of the past few years, particularly cloud services, phone sales and mobile advertising. We have maintained a strong weight in semiconductors, though, as they have already adjusted to lower estimates and still need to rebuild productive capacity given the ongoing chip shortage in key sectors. We also reduced energy exposure but are still overweight in oil stocks, as we see ongoing supply constraints and exceptionally low historical valuations. We reduced exposure to economically sensitive sectors such as consumers (autos, retail and housing), industrial production (steel, base metals and rails), and remain underweight financials. Gold stocks continue to look like a good contrarian play this year as we expect more U.S. dollar weakness, decades-low valuations and a reversal of the tight interest rate environment later this year. For income-oriented accounts, we continue to like the pipeline and telecom companies for their high dividend yields, stable earnings and moderate valuations.

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TOP PICKS:

iShares 20+ Year Treasury Bond ETF (TLT NASD) 

Latest buy at US$101 Feb. 21

Bonds look like a much better risk-reward situation for investors than stocks this year as inflation recedes and the economy slows down, maybe even going into recession. The TLT is an extremely liquid way to invest in the long-term U.S. bond market and provides a hedge for stock exposure in most portfolios. We expect to see a peak in short-term rates later in 2023 but longer-term rates should fall earlier than that as the economic data weakens and inflation comes down.

VanEck Junior Gold Miners ETF (GDXJ NYSEARCA) 

Latest buy at US$34 Feb. 21  

With gold-stock valuations at multi-decade lows, we believe the best way to play any upside in precious metals will not be by the commodities themselves but mining stocks, by a wide margin. The GDXJ gives exposure to a diversified list of growth-oriented gold companies without an unduly heavy weighting in the “slower growth” majors, such as Barrick Gold and Newmont, which make up over 22 per cent of the NAV of the larger GDX.

Baytex Energy (BTE TSX) 

Latest buy at $5.50 Feb. 21   

Baytex Energy has a diversified cash flow base, combined with a focus on debt reduction and share buybacks, which should allow for production growth and a strengthening balance sheet while it returns excess free cash flow to investors. The Canadian operating segment includes light oil assets in the Viking and Duvernay, heavy oil assets in Peace River and Eagleford in the U.S. Two key growth assets are its Clearwater play at Peavine and its early-stage Pembina Duvernay play. 

PAST PICKS: February 7, 2022

MDA Ltd. (MDA TSX)

• Then: $9.46
• Now: $7.84
• Return: -17%
• Total Return: -17%

Alphabet (GOOG NASD)

• Then: $2,778.76
• Now: $91.07 (After 20-for-1 stock split on July 18, 2022)
• Return: -34%
• Total Return: -34%

Torex Gold Resources (TXG TSX)

• Then: $13.36
• Now: $15.69
• Return: 17%
• Total Return: 17%

Total Return Average: -11%