Good morning. Unhedged starts off 2023 feeling pretty good. Stocks are not cheap, exactly, but they are a lot cheaper than they were. Corporate bonds offer positive real returns. Treasuries may not have bottomed, but the short end pays you pretty well to wait. The set-up may not be great, but it’s loads better than what we were faced with a year ago. Email me: [email protected]
Eight big US stocks to watch in 2023
These are not stock picks; this is not a stock tips newsletter. What follows instead are eight big US stocks that stand to be really interesting in 2023. They either face interesting strategic challenges, exemplify key trends, or embody important uncertainties. Of course, if you were just looking for the most comprehensive market barometers, you’d get a kind of boring basket of megacaps (Walmart for the health of the mass consumer; JPMorgan for financial stability; Exxon for the energy market; and so on). I’ve tried to make this a touch more fun than that.
Devon Energy Energy prices were, other than inflation, the biggest story in markets last year, and energy was the only sector that posted positive returns. The year ended with a fascinating development: energy prices fell a lot, but energy stocks did not. The market seems to be pricing in a rebound in energy commodities, and if that doesn’t happen, energy stocks are going to get whacked. No better way to follow that drama than with Devon, which is a leveraged play on oil. Its shares are up almost sixfold since the middle of 2020, when WTI crude was at half its current level. Yet Devon’s shares have hung on to much of their gains as WTI has fallen from $120 to $80 a barrel.
If oil prices should bounce (it’s hard to predict!) Devon will be part of another drama, too. Will companies in the US shale patch maintain the capital discipline that (with some encouragement from Wall Street) has become their new orthodoxy? The street wants free cash flow. Oil people like cash well enough — but they really like drilling wells.
Meta Meta is fascinating in that it is the first of the giant US tech companies to go from being a growth stock to being a value stock. It happened fast. Its price/earnings ratio has gone from 30 to 11 in two years. Will management (read: Mark Zuckerberg) acknowledge that it is now a slow-growth company? Will it find a new constituency among value investors as the growth types head for the exits? Unhedged has already said what we think needs doing, but we suspect Zuck has different ideas.
It’s hard to think of a company that has made the growth-value transition smoothly. Walmart’s growth started to peter out at the turn of the millennium, and its shares stagnated for more than a decade. Perhaps there are market historians out there who can think of better examples?
Boston Properties Boston owns city centre office buildings. There are too many of them, now that people work from home. Some of the buildings have turned into zombies. Boston’s share price, accordingly, has been cut in half since the coronavirus pandemic began. UBS analyst Michael Goldsmith sums up Boston’s situation with an audible sigh:
Macro factors are having an outsized impact on fundamentals, which are likely to get worse before they get better. These headwinds have caused demand to slow in the tech & life science sectors that have been key demand drivers the last decade. Simultaneously, rising interest rates are pushing interest expense higher. This makes investments less accretive and in some cases dilutive . . . there are more questions than answers on office demand . . . We suspect investors will need to see evidence of demand improving before rewarding shares with a multiple closer to historical levels.
From an investor point of view, half off is a nice place to start. And if any office property company can hang in there, it is probably Boston, which has high-quality properties in great locations. But if Boston wobbles further, that means the office property sector is in a simply awful mess.
Invitation Homes Another real estate company, but interesting for a very different reason. Invitation rents out about 75,000 single-family homes. Demand has been incredibly strong, occupancy has been high, overdue rents low, and the company has been able to jack up rents — by 16 per cent on new leases in the first three quarters of last year. This won’t go on forever, but how quickly will things change? Rest assured, Invitation, if anyone does, knows what the market will bear. The stock market appears to be betting that wage growth will fall and rents will follow: Invitations’ shares are back down to pre-pandemic levels. The stock has never been cheap and still isn’t, at over 40 times earnings. On the other hand, might higher mortgage rates support rental demand?
Chipotle The burrito chain is an interesting measure of consumer demand, in that it is a good-sized step up in price from fast food, but is not quite a luxury good, either. Same-store sales rose 7.6 per cent in the third quarter; a bit less than half of that came from price increases. That’s good growth, but a lot slower than 2021. Interesting questions: will demand hold up as pandemic savings continue to dwindle, or will hungry consumers trade down? Specifically, will demand continue to keep pace with wages, which are a third of Chipotle’s costs? All of this gets more interesting in a recession, given Chipotle’s “affordable luxury” status. Like Invitation Homes, the stock is down but not cheap.
Disney The streaming industry has a pricing problem. Consumers love streaming movies and shows because it represents low-cost, all-out-limitless choice. Yet the economics stink, at least compared to what went before, for the people who make the movies and shows. The TV industry is starting to look like what the airline industry has looked historically: consumers are capturing most of the value.
It is worthwhile to recall how the newspaper industry responded when a change in its primary mode of distribution led to a pricing crisis: with a massive, ugly reduction in capacity, from which a few profitable (but not very profitable) players emerged. Shares in Disney, Warner Brothers, Netflix and Paramount all fell by at least twice as much as the market last year. I’m not sure the mayhem is over. Disney has the best content and strongest financial position to start coming up with a solution. It will be fun to watch as they try to figure this mess out.
Caterpillar A straightforward economic bellwether, particularly useful for its significant exposure to China and Chinese real estate. Right now, however, there is an interesting twist: this cyclical stock has not received the memo that the cycle is turning. The shares were up 16 per cent last year, and its results have been remarkably strong. The situation is reminiscent of the gap between oil prices and the prices of oil stocks. Either Unhedged and most other people are wrong about the trajectory of the world economy, or Cat’s stock price has to come down.
Bank OZK You want a bank that’s going to tell you how the US economy is doing? JPMorgan Chase, Bank of America and their ilk are too big, too diversified, and too global to give you much of a signal. What you need is a good old rate sensitive midsized bank with lots of commercial real estate exposure — because most small and midsized business lending is real estate lending, more or less. It’s hard to find a decent-sized bank with more commercial real estate lending than OZK: almost 70 per cent of its loans are in non-residential real estate, spread all across the country. If you have a contrarian bullish view on the US economy or are, alternatively, looking for a canary in the default rates coal mine, OZK is interesting.
We’re very curious to hear which stocks readers are keeping their eyes on. You know how to find us.
One good read
A good case against sending people to Mars. Thanks to Tyler Cowen for the pointer.