Our predictions do not represent our base case scenarios for the year, but instead we wish to promote thoughtful discussion on a range of topics that we may face in 2023.
Each member from the Oracle Investment Management team has contributed two predictions.
We hope you enjoy our predictions!
We have recently completed an analysis of which environments value stocks tend to perform well against growth stocks. While we don’t tend to like this terminology, it is well accepted in the investing community that value stocks are those on low price to earnings multiples, low price to book multiples, and high dividend yields, while growth stocks are those expected to continue growing revenues and profits. Tracking and comparing the returns of two MSCI World indices that track a basket of global stocks with these respective definitions, we found that value tends to outperform growth in periods of monetary policy tightening, and this was especially true when quantitative tightening (the act of central banks selling bonds into the market or allowing their holdings to mature) was involved.
Alongside interest rate rises, the US Federal Reserve and the Reserve Bank of Australia have both indicated they will reduce the amount of bonds they hold on to their balance sheet. This will impact the valuations for stocks in general but is likely to impact the valuations of growth stocks more than value stocks. This paradigm is likely to persist through 2023.
To us, this prediction feels so banal that is hardly worth mentioning at all. Just about all the economic data we are looking at points to a recession. And yet, the financial press, which claims to represent the mainstream thinking of the day still only reports that leading economists and governments only believe there is a 50% chance the economies will enter a recession at all.
Let’s run through some of the highlights, but bear in mind, each of these are probably worthy of an article on their own, so you might just have to take our word for it that they are leading economic indicators:
- The US yield curve is the most inverted it has been in decades.
- Housing approvals, building starts, and house prices are all falling off a cliff.
- The Leading Indicator Indices (which aggregate leading economic data into one index) of both Australia and the US have been negative for several months.
- Purchasing manager indices (an indication of manufacturing purchase managers expected buying activities) of both countries have been weakening.
- The Global Credit Impulse, as reported by The Macro Compass, has turned sharply negative,
- Economic growth forecasts have been falling.
- Consumer sentiment is weak.
Not to mention the lagging and coincident indicators (that show strength or weakness of an economy either after or at the same time an economy enters a recession) that have also turned weak:
- Inflation remains elevated, which will cause interest rates to remain elevated.
- The US has had 2 consecutive months of negative economic growth.
- Retail sales remain very strong (though cycling a weak comparison period in 2021), but this is being funded by a falling savings ratio and increasing credit card spending.
Financial markets are vehemently obsessed with interest rates and what direction they will take over the next 12 months. The common narrative is that 2022 will be filled with constant interest rate rises by central banks, followed by a 2023 where interest rates peak, stall, and begin to come down to revive the global economy. However, we predict that the RBA stays the course and does not cut the official cash rate once during the entire year.
This is our prediction as we believe the RBA will risk sending the economy into a recession to unquestionably kill inflation by keeping rates elevated despite weakening economic indicators, rather than cut rates at the first sign of economic weakness. With the unemployment rate at its lowest rate in 50 years at 3.4%, the economy has a way to fall before the RBA feels the need to cut interest rates and risk reigniting inflation. If nothing else, I believe recency bias will plague the psyche of Phillip Lowe and colleagues. Inflation will haunt their dreams for some time.
There has been a flurry of corporate M&A activity over recent times, the most recent being Brookfield’s generous $9 per share bid for Origin Energy. Prior to 2022’s meaningful decline in stock prices, the market was already rife with takeover activity, fuelled by cheap and readily available debt. Although credit has tightened, takeover activity is still prominent, as domestic super funds and private equity funds have emerged as major players in acquiring listed companies.
Super funds have grown to such enormity that simply buying shares in companies has transitioned to bidding for entire company. One prominent theme we have seen is these super funds buying listed infrastructure and taking them private to expand their unlisted infrastructure offerings, which is in high demand from investors due to the defensive nature of these assets. The unlisted nature of these assets also helps performance figures during market drawdowns, as the valuations are not based on daily price movements on the share market.
Taking our prediction one step further, we predict these five companies to be prominent takeover targets: Transurban (TCL), APA Group (APA), Jumbo Interactive (JIN), Ampol (ALD), and Qube (QUB).
Will Microsoft’s (MSFT) acquisition of video game maker, Activision Blizzard (ATVI), receive regulatory approval? If not, will Microsoft take on the Department of Justice and the Fair-Trade Commission (FTC) in court to consummate its deal to buy the maker of Call of Duty and Guitar Hero?
It is a U$70bn transaction priced at U$95 per Activision Blizzard share to be paid in cash. The breakup fee if Microsoft walks away or loses the legal battle, unable to jump over all the regulatory hurdles, is at least U$2.2bn, and up to U$3bn. At the lower level it amounts to about U$2.90 per ATVI share. That is more than they make in a year – net income was U$2.9bn in FY21 and consensus has it going down to U$2.4bn in FY22. Activision Blizzard’s current stock price is around U$76 per share. If the deal gets through as it stands, there is a potential 25% arbitrage profit to be made by buying Activision Blizzard stock today. Recently there are rumours and speculation in the financial media that Microsoft will fight and should win.
As in any great corporate story there are interesting people and issues involved.
Warren Buffett announced at the FY21 AGM of the company it now owns a whopping 9.5% of video game giant Activision Blizzard. “We now own 9.5%, something like, 9.5% of Activision,” Buffett said. “It is my purchases, not the manager, who bought it some months ago. And if the deal goes through, we make some money, and if the deal doesn’t go through who knows what happens.” The stake, which is worth some U$6bn, is a large increase from the U$1bn Berkshire Hathaway purchased before Microsoft announced it is buying Activision Blizzard.
The 28-year-old ex-Yale adjunct and anti-big company crusader, Mrs. Lina Khan, President Biden’s appointed FTC Chairman, is reportedly at odds with the rest of the FTC commissioners and management. This kind of conflict seems common when activists try their hands at doing things not equipped to do. Mrs. Khan is reported to want to fight this and many other corporate deals that, on the face of it, do not seem to me to contravene competition law. The Yale Law Journal’s article by Lina M. Khan titled “Amazon’s Antitrust Paradox” makes for interesting reading and once again underscores how out of touch academia in general is with the “real world”.
It is two predictions with no resemblance between the two events. It is rather a focus on Elon Musk and the way forward for the entrepreneur now in charge of five companies: Tesla, SpaceX, Twitter, Neuralink and The Boring Company.
Jason Portnoy, a former Vice President of Finance at PayPal, where Musk was CEO in 2000, told the “Tim Ferriss Show” podcast in June 2022 that one of his biggest observations from working with Musk, Peter Thiel, and Reid Hoffman members of the so-called PayPal Mafia — is that “they were never only doing one thing at a time”.
To quote Portnoy – it was interesting because, logically, when people work on something, they focus just on that thing. Musk, Thiel, and Hoffman were involved in multiple companies and ventures during and after their time at PayPal.
Jack Dorsey is no different, having founded Square (now called Block) and Twitter, the latter company now firmly in the hands of Elon Musk after taken private at the end of October 2022.
Since the Tesla CEO took control of Twitter in October 2022, the company has been hit by job cuts, an advertiser boycott, warnings of bankruptcy and then a mass resignation among its staff. The financial problem of Twitter is well documented. The company incurred losses in ten of the last twelve years, and ongoing loss of advertising revenue, the major source of revenue, could prove to be the “last nail in the Twitter coffin”. It is too early to say whether the new subscription service to be launched (at U$7.99 a month) will find appeal with Twitter users.
Satellite Internet connectivity is provided by Starlink and operates as a division within SpaceX. The company became “famous” for provision of its services in Ukraine, post the Russian invasion of the country. It is perhaps time for Starlink to be separated from the rest of SpaceX and allow it to focus on commercial satellite communications only. There are many developments with military applications only, such as Starshield which is a new SpaceX program focusing on Government use in defence.
There is a consensus view that the property sector underperforms in a rising rate environment, and the performance of the A-REIT 200 index (XPJ) index this year supports that theory. As at the end of November the index was down -17.20% and if it weren’t for the recent market rally this figure would look a lot worse.
The rapid increase in interest rates this year has the market concerned about the amount of leverage carried by real estate investment trusts (REITs). We believe the market is overreacting to this as average leverage ratios in A-REITs have decreased from 46% to 31% over the past decade and interest payments remain at reasonably low levels.
REITs can also benefit from the current economic environment. The reason central banks need to increase rates is due to a strong economy with low unemployment rates and consumer demand causing high inflation. Given that most rents are tied to inflation, property managers will see a rise in income. From our research we found data suggesting that A-REITs have returned 7% p.a. in the past five RBA tightening cycles.
It is for these reasons we believe that property will bounce back in 2023 and outperform the broader market.
With the housing market cooling off this year Aussies have needed to replace their go to conversation starter around the BBQ with another asset. Hello lithium. The lithium price has more than doubled this year, providing investors in listed lithium companies with great returns in a volatile market. However, the lithium price is forecast to soften next year with increasing supply coming online, dampening the chance of seeing 2022 like returns in 2023.
The decarbonisation of the world will require many different metals, not just lithium. For example, the production of an electric vehicles requires 6x the number of metals than a traditional petrol car. When thinking about the electrification transition it is difficult to go past copper due to its conductive properties. Compared to a traditional petrol vehicle, electric vehicles require over double the amount of copper for production. A much larger percentage of copper is also required for green energy projects like solar and wind compared to your traditional power producers.
Despite copper historically performing poorly in an economic downturn, the developed world is speeding up their transition to green energy. This will see the demand continue even if we are to enter a recession. The supply side response to the increased demand has also been slower than expected which I believe will push prices higher in 2023.
We expect our team predictions have raised further discussions in your circle.