The bear has yet to release its grip on the equities markets. And recession talk continues to swirl. That's why top mutual fund managers are looking to bulletproof their portfolios in 2023.
So, what are fund managers' stock picking favorites for next year?
In a word: survivors. Stocks that can grow earnings in a recession. Beaten-down names whose long-term growth stories remain intact. Dividend earners. And companies positioned to take advantage of increased spending on U.S. infrastructure and a shift toward more domestically focused supply chains and manufacturing.
Stock Picking: Fund Managers Are Positioning Portfolios For A Recession
In 2022, of course, bear markets battered most asset classes. The highest inflation in 40 years and aggressive Federal Reserve interest rate hikes intended to bring down consumer prices cooled investor risk-taking and stock performance. The S&P 500, down as much as 26.7% for the year in mid-October, was still off about 19% through Dec. 29, on track for its worst year since 2008.
The Nasdaq, down 34% for the year as of Dec. 28, and the Russell 2000 small cap index, which has tumbled 21%, are also on pace for their worst annual returns since the financial crisis. Bonds tumbled too, with the benchmark Bloomberg U.S. Aggregate bond index down more than 12%, its worst year ever.
If there's a silver lining to the nowhere-to-hide market of 2022, it's this: There's a lot of bad news already priced in.
Fund managers surveyed by Bank of America put odds of a global recession next year at 77%. However, the major headwinds of 2022 — namely Fed tightening and interest rate hikes and sky-high inflation — may be less of a drag next year.
Slowing economic data, Wall Street pros say, suggests that the Fed may lessen its rate hikes and begin reducing borrowing costs in 2023. The Fed's latest rate hike was less than previous hikes. However it signaled it will continue to hike interest rates in 2023. Price increases for goods are moderating, though not as much as the Fed would like.
Inflation is still the key variable to watch, says Edward Yardeni, president of Yardeni Research.
"You need more signs that inflation is moderating enough to convince the Fed to give it a rest," Yardeni said. If the bulk of the Fed's inflation-fighting rate hikes are indeed behind us, then odds of a soft landing, or mild recession, rise. And that means markets can start pricing in an eventual recovery and there will be better stock picking days ahead.
But until the inflation threat dissipates, Yardeni said, "Keep your guard up."
Top mutual fund managers are positioning their portfolios to profit no matter what. Here's where they're putting their money as the new year kicks off.
Companies With Teflon Earnings
In a slowing economy, corporate earnings will slow. That will create fresh headwind for stocks. Goldman Sachs is forecasting no growth in profits for the S&P 500 next year. Bottom-up analysts expect 2023 earnings growth of 4.8%, according to earnings-tracker Refinitiv.
When earnings growth is scant, it puts a greater premium on picking stocks that can grow profits in a slowdown, says Jim Tierney, manager of AB Concentrated Growth Fund (WPASX). "We're trying to bulletproof our portfolio," Tierney said. "Who can deliver positive earnings growth? If you can find those companies, I think you'll do well."
Tierney likes long-term growers with Teflon business models. Their sales stay steady even in bad times.
Credit card processor Mastercard fits the mold as it earns a swipe fee every time a card user buys something with a Mastercard. The company, which grew sales 15% in the third quarter, is a play on the transition from cash to credit cards.
"When you go into a tougher environment, is Mastercard's profit growth going to zero? Not a chance," Tierney said.
Discount broker Charles Schwab is also positioned for strong profitability, Tierney says. Schwab, which has 34 million brokerage accounts, is benefiting from continued investor cash inflows to its funds and brokerage accounts.
A record $6.6 billion in net investor cash flowed into Schwab in the third quarter. The brokerage is also profiting from higher interest rates, as it earns more revenue on its clients' cash balances, Tierney says.
Look For Dividend Payers
With market volatility expected to continue, adding the stability of dividend-paying stocks to your holdings could smooth out a bumpy ride. "The current income stream associated with dividends is attractive," said Matt Quinlan, an equity portfolio manager at Franklin Templeton.
"Dividend-payers tend to be larger, more-established companies, which indicates reliability of cash flow and consistency of results over time," he said. Quinlan also says health care companies that pay dividends look attractive. This typically defensive sector benefits from strong cash flow, innovation and the aging population.
Quinlan also sees dividend opportunities in sectors such as technology, industrials and financials.
Non-Discretionary Stocks With Growth Potential
Investing in companies selling items customers must buy no matter what is a prudent strategy when the economy is teetering on recession, Tierney says. "The non-discretionary part of the economy is what I'm focusing on," Tierney said.
Tierney's AB Concentrated Growth, an IBD Best Mutual Fund Awards winner for 2022, likes Cooper
Companies, a medical device maker with a big contact lens business. "Who's going to give up their contact lenses" just because the economy is bad, Tierney said.
Gene-sequencing company Illumina, a big player in gene-sequencing research, is another business that won't be put on hold in a downturn, Tierney adds.
The mutual fund manager is also bullish on animal health company Zoetis. It makes medicines for livestock and companion pets like dogs and cats. Zoetis is a stock picking play on the "pet parents" trend. It's benefiting from increased demand for its drugs, greater market share and an innovative drug pipeline, Tierney says.
Picking Cyclicals With Growth Prospects Intact
Picking stocks in cyclical parts of the economy may also yield results. Companies in the semiconductor capital equipment space, which have suffered sharp declines in the bear market, are ripe for rebounds, says Tom Hancock, manager of GMO Quality Fund (GQLIX), another IBD Best Mutual Fund Awards winner in 2022.
The reason? The trend toward all things digital isn't going away, Hancock says.
Sure, chipmakers like Micron Technology have said they're cutting back on capital spending to clear out excess chip inventory. But companies that make products and equipment used to make semiconductors, such as Lam Research, KLA, and Applied Materials, now have two things going for them. One, they're trading at lower valuations and more reasonable prices, says Hancock. Two, they're still in a business with big growth potential.
Chip equipment makers will also benefit from the shift to domestic production of chips and wide economic moats around their businesses, Hancock says. "We like stocks with secular drivers (that are benefiting) from long-term trends happening in the world," Hancock said. "I'd rather be early" (to the rally).
Small Stocks With Big Opportunities
Don't count out small-cap stocks just because the Russell 2000 index's decline in the first three quarters of 2022 was its fourth-worst start to a year in history, investment bank Jefferies says. Why? Following 2002, which was the worst-ever nine-month start for the small-stock index, the median gain for small cap stocks the following year was 16.9%.
Ken Farsalas, manager of Oberweis Small-Cap Opportunities Fund (OBSOX), and Micro-Cap Fund (OBMCX), both IBD Best Mutual Fund Awards winners in 2022, says historically the best time to buy small caps is when fear is palpable.
He likes two small stocks that are benefiting from trends that insulate them from any downturn. Aehr Test Systems makes testing equipment for silicon carbide wafers that are key parts used in engines in the fast-growing electric vehicle market. Federal Signal makes things like street sweepers, road marking equipment and public address systems. It will benefit from ongoing infrastructure spending, Farsalas says.
"When it comes to spending in these areas by local governments, the money is only starting to flow in,"
said Farsalas.
Beneficiaries Of Local Supply Chains
Stocks that can shorten the domestic supply chains and manufacture things at home will be in greater demand post-Covid, says John Barr, manager of Needham Aggressive Growth Fund (NEAGX). That's the new "investment lens" he's looking through for his 2023 stock picking.
He likes Clean Harbors, a green stock picking play known for collecting and recycling used oil and reselling it in a usable form. "It's the equivalent of a USA oil field without the cost of drilling," Barr said.
He's also bullish on infrastructure play Parsons. It designs and builds bridges, airports, highways and tunnels. And it assists the U.S. armed forces with cyberwarfare technology.
Another stock picking play that benefits from infrastructure spending is Smith-Midland. It's a maker of concrete barriers used on highways, in construction areas and for crowd control.
