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While there are many challenges in 2023 including a potential recession, we are finding strong investment opportunities in select growth companies. Some growth companies could very well outperform the broader market indices, even in a recessionary period.
The top five performing sectors to start 2023 were the five worst-performing sectors in 2022; the top five performing sectors from 2022 have started 2023 as the bottom five. Indeed, the energy sector outperformed the technology sector by more than 90% in 2022! (see Figure 1 below)
Look at 2022 and 2023 as part of a multi-year period to properly judge asset class performance, both at a market return and company fundamental level. While there were “stay at home” beneficiaries in 2020 that unwound last year, there were “inflation” beneficiaries in 2021 and 2022 in the cyclicals and staple sectors. Notwithstanding the recent outperformance of growth, we see five reasons this outperformance will continue the rest of the year. And some of these reasons explain the outperformance we’ve already seen in January.
1. Growth companies are starting 2023 with both lower estimates and lower valuations, a better investment set up for them in 2023 along with a more stable cost of capital environment. As shown in Figure 1, growth sectors like technology and communication services are starting 2023 with both meaningfully lower stock prices and earnings estimates. The drawdown last year in these sectors makes the investment set up better this year as risk rewards for upside potential to downside potential have improved drastically.
2. The valuation gap between growth and value companies has closed, and growth companies are more attractive. Value indices have seen their multiples decrease from 23x to 19x over the course of 2022, a 4x decrease; growth companies have seen multiples fall from 33x to 24x, a 9x decrease. Valuation alone does not drive positive outcomes in stocks – you need earnings estimates to go higher as well. However, on a growth-adjusted basis, growth companies are now cheaper than value companies and we expect a more level playing field in stock performance across all sectors. (See Figure 2)
3. The “micro” should matter more. Small-cap stocks were the best-performing asset class in the 1970s by a factor of 2x. Once the Fed pivoted to reduce interest rates in 1973, small caps materially outperformed other asset classes. This could happen in 2023 as the cost of capital should be more stable this year (Fig. 4).
4. The themes have not changed! While 2022 was not a favorable year for most growth areas, the factors that are shaping our world for years to come have not changed. Electric vehicles, the desire to live longer lives through medical advancements and healthier lifestyles, and consumer interests such as shopping (both online and in store), dining and traveling are all intact (see Figure 3 regarding electric vehicles). We exited 2022 with one of the most profound advancements we’ve seen in artificial intelligence via ChatGPT as well as critical progress in clean energy technology with the advancement of nuclear fusion. That was an ironic way to end 2022 given oil companies dominated the markets most of the year.
5. Foreign exchange rates are more beneficial for U.S. stocks and China is reopening from COVID lockdowns. Foreign exchange rates have materially improved for U.S. investors over the last three months with the dollar weakening and other currencies stabilizing. This is a very good dynamic for U.S. companies that sell internationally as their foreign profits are worth more in dollars this year than they were last year. China has removed COVID lockdowns and while this resulted in spread of COVID initially, this spread has subsided. Unlocking the world’s biggest economy could be a material driver.
Lorne and Douglas Bycoff are co-founders of The Bycoff Group, a NYC-based investment management firm. Lorne is the CEO and Douglas is the chief investment officer.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
