It is that time of year where we are tasked with identifying a top pick for 2023.
Before I make my pick, however, I want to put the new year in perspective. I'll start with my macro outlook: The economy is going to slow dramatically in the first quarter. We will see deflationary, rather than inflationary, pressures. My base case is that stocks will break the 2022 lows in a "classic risk-off" trade. But, after that, I see the ongoing shift in supply chains as supportive for the domestic economy and the ongoing "sustainable" energy buildout as helpful and inflationary.
So in good conscience, I cannot pick shorting stocks as a top pick (shorting stocks should rarely be a top pick in any case, but that is a trading strategy, not a strategy for the year, and on top of it, I'm long risk at the moment, so it doesn't make sense).
Bonds are a more obvious choice for me. Even under my "optimistic" case, inflation has peaked and is manageable and the Fed will be able to back off. Even in my back half of the year scenario where the impact of sustainability and supply chain revamping kicks in, inflation will be in the 3% to 4% range, which shouldn't cause too much angst.
But saying you like "bonds" has two issues -- it is too broad and it is a bit wimpy, so we will address both.
The bonds I like:
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I prefer something around the 5-year maturity. The longer end of the yield curve has priced in a lot already. It is attractive, but the risks if I'm wrong are high. So, that is my maturity preference. I prefer the iShares 3-7 Year Treasury Bond ETF (IEI) for example over iShares 7-10 Year Treasury Bond ETF (IEF) or the bond fund (TLT) (20+ year), and the iShares 1-3 Year Treasury Bond ETF (SHY) (1-3 year) is too short to get much of a kick if I'm right. (There are ETFs by other issuers that fit the bill as similar to IEI).
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I prefer Treasuries over credit risk. I do not like high yield or leveraged loans here (too risky if I'm right on the economy). Corporates, in that 5-year end of the range, should do OK over the course of the year, but it could be a volatile start. The Vanguard Short-Term Corporate Bond Index Fund ETF (VCSH) (1-5 years) is a decent way to do this, though the Vanguard Intermediate-Term Corp Bond Index Fund ETF (VCIT) (intermediate maturity) is more interesting, but riskier. Something with investment-grade credit risk and 5-year sort of average maturity could work.
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I could be convinced on municipal bonds, mortgages and structured risk. Structured credit, even collateralized loan obligations, or CLOs, backed by leveraged loans, could do well over the course of the year. The municipal bond market faces some of the same issues as corporate credit and I prefer managed funds for these, even closed-end ones. Mortgage backed securities are down over 11% on the year and I think could bounce nicely next year. The Janus Henderson AAA Collateralized-Loan CLO ETF (JAAA) is interesting. It's got a nice mix of income with some chance of appreciation and it is approaching $2 billion in assets under management. The Janus Henderson B-BBB CLO ETF (JBBB) is even more interesting, but is too small for most to consider.
So on the bond side, my top pick for one position is the IEI.
But bonds are boring, at least at these levels. Where can I apply my macro outlook and come up with something with more upside, while still liking the risk vs. reward?
For this I keep gravitating to the energy sector. I am increasingly dubious about the "greenness" of EV's as batteries are an issue, tire wear another, but most of all the need to build all these charging stations seems both inflationary and not environmentally friendly (at least up front). And I've always been dubious about some of the claims, but I've learned (much like with the Fed) I'm not paid to figure out what policy I'd enact, but what policy the powers that be will enact.
So there is something in the energy space that has a compelling story, an is not fully priced in.
Finding compelling stories is easy in the energy space as the push to build sustainable energy while ensuring we don't fall victim to underinvestment in traditional energy (like Europe did) creates plenty of opportunity. Finding ones that aren't priced in, is a different matter.
In the end, I want to own nuclear or power generation. This would be my top pick for a "riskier" portion of my portfolio.
The uranium ETF (URA) is more on the uranium side of things, while uranium and nuclear ETF (NLR) has more of the generation companies.
I expect nuclear to gain traction as countries try to figure out a plausible way to transform our energy systems and policies and I think there is upside from here as I'm more bullish on this trend than the market is currently pricing in.
I am doing some work on "carbon offset" opportunities, but am not there yet.
I am not quite sure I fulfilled the Top Pick 2023 mandate, but I'd be heavily overweight a bond ETF in my portfolio (IEI) with a small but noticeable bet on nuclear (NLR) if I really was going to put my portfolio under lock and key for the year.
Thanks again for all you support this year and hopefully we can navigate 2023 just as successfully (though less volatility would be nice in many ways).
