7 Themes for Stock Investing in 2023: John Buckingham

Q&A December 14, 2022 at 05:25 PM

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Expert stock-picker John Buckingham, principal and portfolio manager at wealth management firm Kovitz, articulates perhaps the best logical reason to be bullish about 2023: "Stocks will perform better than they have historically, on average, because they performed far worse this year, on average," he said in a recent interview with ThinkAdvisor.

Buckingham has managed the Al Frank Fund (VALAX) from its 1998 inception. Since then, through Dec. 6, 2022, it has had an annualized return of 10.03%.

In comparison, the Russell 3000 Value Index and the S&P 500 Index have seen 7.33% and 7.75% returns, respectively.

Buckingham oversees $825 million of Kovitz's approximate $8 billion total assets under management and advisement.

In the interview, he forecasts the stock and bond markets for 2023 and reveals his seven themes for equity investing next year.

The value manager likes laggards, and in 2022, there have been a slew of them. Some of the beaten-up stocks he favors for next year are Apple, Bank of America, BlackRock, General Motors, MDC Holdings, Microsoft, Sanofi and Target.

Buckingham, editor of The Prudent Speculator newsletter, this year celebrating its 45th anniversary, believes the market has already discounted "a significant portion of a recession."

He sees a "mild recession" in 2023 but looks for the stock market to return 13%, while value stocks, he argues, will be up 15%. Value has outperformed the broad market this year, but the Al Frank value fund is down 11% mainly as a result of its robust weighting in technology stocks.

Buckingham was interviewed by phone speaking from his home office in Laguna Beach, California. Kovitz is headquartered in Chicago, with an office in Aliso Viejo, California.

Here are excerpts of our interview:

THINKADVISOR: What's your forecast for the stock market for next year?

JOHN BUCKINGHAM: 2023 will be a good year. Stocks will perform better than they have historically, on average, because they performed far worse this year, on average.

I expect returns to be about 13% for the market and 15% for value [stocks].

Another factor supporting higher prices next year is that it will be the third year in the presidential cycle, and that historically is the best of the four years.

It's also likely that investors will look at stocks a little more favorably because the Federal Reserve is likely to be done raising interest rates next year. So the potential of more rate increases won't be hanging over investors' heads.

The stock market is an anticipating mechanism; the fact that we're down this year means it has discounted something. It could be that interest rates have gone up more than people had thought, or it's discounted an economic slowdown.

What's your forecast for bonds in 2023?

They'll be okay, even if they tread water in terms of price.

The irony is that this year value [investing] is doing better than bonds. All the smart people who said, "Stocks are a bad place to be, so I've got to hide out in bonds," have done worse than if they stayed the course in a value stock portfolio.

Do you foresee a recession next year?

I would argue that we've already discounted a significant portion of a recession; and that's why stocks are down 17% or 18% [on the S&P 500 Index] this year.

The definition of a recession is two quarters of negative inflation-adjusted GDP growth. We've had that in the first and second quarters of this year.

Stocks often rally in the middle of a recession, so we might expect the market to rally even if the economy is now suggesting that we're in a recession.

But what are your thoughts about a recession next year?

The odds suggest there might be one, but it's likely to be mild.

Did value investing live up to your expectations this year?

It's outperformed the rest of the market by a wide margin — so it's lost less.

For us, it's been a good year because we've outperformed the overall market. On an absolute basis, it's been a bad year for us: Our mutual fund is down 11% for the year. Last year it was up 28%.

What happened in your portfolio in 2022?

Our energy stocks and health care stocks are up.

Our tech weighting hurt us this year. We have a lot of stocks. Our technology stocks are down considerably, as are our consumer discretionary stocks, communications service companies and REITs.

What's your outlook for the tech sector for next year?

I continue to like tech companies in general. They're going to grow faster than the overall economy. Their financial health is better, on average. They have lots of cash. They don't require lots of capital to grow, fund or maintain their businesses. And many of the companies pay nice dividends.

Technology is a place that value investors should be moving toward.

You have seven different investing themes for 2023. Please talk about the first one, "Quality Merchandise on Sale," and the stocks that you like.

These are marked-down, high-quality marquee stocks that were down significantly this year. Generally, they have very high credit ratings.

Because of worries about tech spending, the big network equipment company Cisco Systems has been a laggard this year.

Asset manager BlackRock has struggled with its stock price, but it hasn't struggled from an earnings perspective.

Diversified health care firm Abbott Labs had the baby formula problem.

All these [issues] are temporary and likely to be overcome in the fullness of time.

Now is when you want to buy these sorts of stocks.

Another theme is "Marked-Down MegaCap Darlings." You single out Meta Platforms, Alphabet (Google), Apple and Microsoft. Please discuss.

Apple and Microsoft went down more than any other stocks in our portfolios. These are great companies at reasonable valuations with phenomenal balance sheets and shareholder-friendly management. They have dominant positions in their businesses.

They're formerly companies that were in everybody's portfolio; now people have dumped Meta [for example].

These are all long-term survivors and thrivers that have been hit hard this year. They have great balance sheets and are likely to weather the short-term difficulties to continue to gain market share and grow over the long haul. You get above-average growth at reasonable prices.

We first bought Apple many years ago. Our cost basis in Apple is 39 cents. Apple is down 20% this year. So, is Apple a bad stock or a good stock for us? This year it's bad. Overall, it's great.

Google and Meta are fantastic companies with tons of cash, minimal debt relative to that cash and are buying back lots of stock.

A third theme is "Consumers Are Still Hanging In." Please elaborate.

Retailers Target and Nordstrom, and toymaker Hasbro are all experiencing short-term difficulties but are going to thrive in [due course].

Target over-ordered merchandise when they couldn't get it because of the backup of container ships. Hard-hit Nordstrom is poised to rebound.

Hasbro has had issues relating to collectors' concerns that they overprinted trading cards. It was a supply-chain issue.

Your next theme is "The Fed Punches a Hole in the Punch Bowl." Please explain.

The Federal Reserve has increased interest rates across bond-land, but this should benefit regional banks like Citizens Financial and Bank OZK. The large money centers, like Bank of America and JPMorgan Chase, have diversified money streams and reach.

There's value to be had at the banks, plus you're getting nice dividends that are increasing because the banks are becoming more profitable.

However, even though they've done well generally relative to the overall market, they had a pullback of late.

Theme number five is "EV's Are Accelerating. But Fossil Fuel Is Not Going the Way of the Dinosaur."

Everybody is excited about electric vehicles. General Motors [for example] is putting a lot of money into its internal-combustion-engine cars and using that [profit] to finance its EV initiative. It's moving up its "electrification" plans by years.

Tesla has been a disaster in terms of its stock this year. It's not going bankrupt. But in order to buy Tesla, you're paying a very high multiple. I'd much rather own GM.

Oil deserves a place in the portfolio, and two very good names are Civitas Resources and EOG Resources. We've seen oil stocks do extremely well this year, but I think there's going to be a supply problem; we don't have incentives for companies to go out and explore oil because of government regulations.

So the legacy companies that have already made investments are likely to be the beneficiaries when we have the inevitable oil price spikes [during] geopolitical events that cause concern about the global supply chain.

The situation around oil is always going to be a headwind because oil pollutes the environment, even though electric vehicles might actually create more greenhouse gases because you have to dig lithium out of the ground for EV batteries, and there's an environmental cost of doing that.

Then you have to charge the batteries, which is usually fueled by fossil fuel.

What are your thoughts of investing in companies whose products go into making batteries?

You'll need more and more lithium to satisfy the demand for batteries. Albemarle is a company that produces lithium. It's trading at less than 10 times earnings. So even though it's done extraordinarily well, it's still reasonably priced.

We consider the electric vehicle "gold rush" in the early stages. Albemarle is a "pick-and-shovel company," selling products to the "gold miners" [as it were]. They aren't going to be the ones to find the gold, but they'll get rich selling stuff to everybody searching for the gold.

The next theme is: "It's a Great Big World Out There." You're talking about international?

Right. International markets have performed poorly this year in their own currency; and because the dollar has been so strong, when you translate it into U.S. dollars, they've been a disaster.

But Europe will ultimately emerge on the other side of its recession. I want to invest in businesses that are going to make it through, such as Deutsche Post; DHL [couriers] is a division. Deutsche Post also is a German mail carrier.

Sanofi is a French drugmaker. They're a big name in drugs in Europe and have a nice dividend, but they've lagged behind — and that's the reason we like it.

Manpower Group, a staffing services company, is heavily exposed to Europe. They've been in business for seven decades and profitable. I think they'll do just fine.

This is the time you want to be buying European-exposed companies.

The seventh theme is "Good Things Come in Small (and Mid) Packages." Why do you like some of these stocks?

Over the last decade or so, large caps have outperformed small caps, which have lagged, though historically, small- and mid-cap have outperformed large cap over the long term.

We essentially invest using strategies that have done well historically and think that they'll continue to do well.

I like exposure to U.S.-based companies that are trading at very reasonable valuations.

Four companies that have been hit hard this year:

Greenbrier Cos., a railcar manufacturer, has already had their downturn and are likely to see another upswing in 2023 or 2024.

MDC Holdings is a homebuilder. The housing market has been hit very hard. But there's still a shortage of housing in the U.S. MDC is very well capitalized. They have a dividend yield of over 6%, and that's been increasing. Over the years, they've had 7% or 8% stock dividends.

Lumentum, an optical and photonic [lasers, optical fibers, for example] product supplier of networking equipment, has been extremely hard hit on worries about overall tech spending. But we think that substantial profits are likely to continue going forward. Though a lot of companies' stocks have been hit hard, their earnings have not been. That's the fascinating thing.

[The final stock included in this seventh theme is] EnerSys, which makes industrial batteries, like fork-list batteries. There had been a big boom in warehouse expansion, but the economic slowdown has [brought that] to a screeching halt. So that part of its business is struggling.

The stock price has reacted violently on the downside far more than it should based on what we think is their long-term earnings goal.

Broadly, what do you foresee for corporate earnings in 2023?

Profits are going to continue to be healthy because nominal growth is likely to be strong even if real growth is negative.

Corporate profits are measured in nominal dollars. Generally, companies can pass on higher costs to their customers, and so stocks historically have been a very good inflation hedge.

What's one thing that guides your investing?

There are all sorts of historical [statistics] that say that when the economic numbers are awful, that's when you want to be buying stocks, not when you want to be selling.

John Buckingham (Photo: Andrew Collins)

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