Last year was tough for most investors. Nearly every sector suffered losses except for energy, while defense contractors and pharmaceutical companies were other examples of outliers.
Fortunately, the first few weeks of 2023 have been better, thanks partly to some encouraging data showing that inflation and wage growth are beginning to decelerate. Yet, as the earnings season continues to play out and corporate layoffs pile up, questions are mounting about the strength of the U.S. economy.
In addition, with policymakers devoted to keeping interest rates “higher for longer,” stocks could come under more pressure in the short term. Yet, at some point, the focus will shift to the future.
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Indeed, while much of the above paints a bleak picture, the outlook is more favorable for select sectors. That includes medical technology and alternative energy, which are being propelled by some beneficial tailwinds.
By contrast, one sector that traditionally holds up during challenging economic times — consumer staples — may struggle over the next few years. Let’s take a closer look.
Pent-up demand for medical technology
During the pandemic, large swaths of technology took off.
Medical technology was not one of them, with hospitals putting many elective procedures and surgeries related to non-life-threatening conditions on hold. That has created a lot of pent-up demand today.
Additionally, many firms in this space could soon benefit from new products that help treat ailments, including diabetes, sleep apnea and arrhythmia, that plague millions of people. It’s also worth noting that higher interest rates are less impactful for medical technology. Unlike other industries that borrow large sums to chase growth, medical technology generally isn’t heavily leveraged.
Names worth considering include Insulet (PODD), whose primary offering is a wearable pod that allows diabetes patients to forgo daily insulin injections. It recently cited strong demand for its newest version of that product.
Dexcom (DXCM) is another company addressing the needs of diabetes patients through a glucose-monitoring device. Its latest model, which is set to launch in February, is 60% smaller and warms up 75% faster than previous versions.
In the meantime, a subsidiary of Inspire Medical Systems (INSP), Inspire Sleep, has what could be a game-changing sleep apnea treatment. It’s a small device that doctors place within the patient, a contrast to how medical professionals dealt with the issue until very recently: with a clunky, awkward and obtrusive CPAP apparatus.
Government support for alternative energy grows
Whether the Inflation Reduction Act will do anything to bring down costs is a matter worth debating. But less arguable is that it is the latest example of the massive amount of policy support that exists from governments around the world for green tech firms focused on producing alternative energy sources.
The U.S. Department of the Treasury is still hammering out the details about who gets what. We’ll likely learn more sometime during the first quarter. But make no mistake, several companies that have been surprisingly resilient during the most recent downturn will have an influx of new capital at their disposal to improve their fortunes even more.
Among those that could do well are Array (ARRY), a utility-scale solar panel producer. Also worth keeping an eye on is SolarEdge (SEDG), which is focused more on the residential market in Europe.
Consumer staples not a best bet anymore
Last year, many investors flocked to defensive, income-paying consumer staples. And for the most part, that strategy paid off, with the Vanguard Consumer Staples ETF easily outpacing broad market indexes over the last 12 months, all while providing a dividend of about 2.4%.
However, in recent months, valuations for many of these stocks have become far too rich. In fact, consumer staples are as expensive as they have ever been relative to the S&P 500 Index.
Therefore, anyone investing for growth (versus dividends) should reconsider their defensive holdings. Indeed, the likes of Johnson & Johnson (JNJ) — which makes many consumer staple products despite technically being a health-care stock — Proctor & Gamble (PG) and Kimberly-Clarke (KMB) have likely hit a valuation ceiling.
A Warren Buffett moment?
Expect indexes to give back some of this year’s early gains in the weeks ahead and perhaps test 2022 lows. In general, though, we won’t see a Warren Buffett-type buying moment on the horizon. That’s because sentiment is already bearish and positioning is light, which should limit the downside overall.
Still, a couple of sectors have the potential for outsize returns once the challenges associated with higher interest rates and a challenging economic landscape begin to fade.
– By Andrew Graham, founder and managing partner of Jackson Square Capital