Growth at a reasonable price and relative value are two core principles that I’ve always espoused in my investment philosophy. They come in handy this time of year for tax loss selling bargains. This week in our weekly webinar, we take a bigger picture look at where the bargains might be for longer-term growth investors and what we are looking to accumulate into the next period of weakness for global equities. It should not surprise anyone that we are expecting a recession in 2023 and that the earnings outlook for the market does not reflect this high probability outcome. Our first chart shows the current S&P 500 (YTD) with the 2023 expected earnings per share (EPS) bottom up consensus. From the $206 in earnings in the bank in 2022, it shows a 14% growth from here. On what planet does that make any sense at all if the recession call is even remotely close? Forget the Fed pause, there is a gross mispricing here.

The first place to look for bargains are in the underperforming sectors. The table below is the YTD bottom 20 industry groups in the S&P 500. Software, Semiconductors, many REIT sectors, consumer goods, autos, retailers. One problem with just looking at this table is that the loss is relative to the beginning of the year and that means you believe the bubble highs were correct in terms of value. If we indeed see the Fed maintain rates higher for longer in 2023, then many of these sectors will have trouble holding rallies because they were priced off a cheap money economy that may take a while longer to come back.

If we exclude (minimize) the stocks that were priced off meme craze or cheap money, we can see lots of value in real economy bellwethers. One good way of doing this is by looking at an equal weight index versus the market cap weighted index. RCD is the Invesco Equal Weight S&P 500 Consumer Discretionary ETF. We can compare its performance versus the S&P 500 and the market cap S&P 500 Consumer Discretionary ETF (XLY).

Relative strength analysis is the comparison of returns over a long period of time. We see this relationship in the lower part of the charts. In the consumer cyclical sector, the top few stocks make up about 50% of the index (AMZN, TSLA, MCD, HD, LOW) and the top two make up one third. This skews the performance of the sector considerably. Currently, it’s more AMZN and TSLA that have been weighing on the index than it is that the average stocks is rallying, but the shift is developing and this is a key area to look for ideal tax loss selling candidates. The combination of value and a momentum shift is key.

When we start digging into the sector, we see that the average consumer stock is beginning to perform better than the market cap weighted stocks. This is almost entirely AMZN and TSLA that are both still very over valued. But there are several stocks in the sector that are mostly, but not entirely pricing in lots of bad news for the economy in 2023.

One example that we have been accumulating for many months is GM. We do not think the coast is clear just yet, but the relative value is there and the catalyst of a peak in rates, improvement in supply chains, and then a decline in rates is what the sector needs. We are much closer to a bottom here than in TSLA. We also like consumer stocks that are already back to pre covid levels. Auto stocks have been amongst the worst performers this year though you might argue their valuation a year ago was not sustainable and you’d likely be correct.

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