Stocks: Tech Is Booming But Other Sectors Are Worth a Look
As tech continues its rally, financial expert Gordon Pape looks at some other sectors that could be on the rebound in the near future. Photo: Catherine Falls Commercial/Getty Images
Last December, the head of the International Monetary Fund warned to buckle up for a rough ride. Kristalina Georgieva said 2023 would be “a tough year, tougher than the one we leave behind.” At least one-third of the global economy would be in recession by year-end, she forecast.
That was a worrisome prediction as 2022 was no picnic. Soaring inflation forced central banks to raise interest rates at a pace not seen in decades. That resulted in stocks sliding and the worst bond market retreat since the early 1980s. Who needed more of that?
Well, it hasn’t happened, at least so far. The first half of 2023 is behind us, and it has turned out better than expected. Inflation has declined and, while rates look poised to move a little higher, it appears the worst is behind us. As for the long-predicted recession, it may still happen, but it’s coming in slow motion and the consensus now is that it will be mild.
Stocks have had a mixed response to these developments. The better-than-expected economic news has raised concerns that the Federal Reserve Board and the Bank of Canada may push rates higher than originally anticipated. It’s the old “good news is bad news” stock market story.
That’s had a deflating effect on most stocks, except for the tech giants. Nasdaq ended June with a first half gain of 32 per cent, far and away outpacing all other North American indexes. The S&P 500 was a distant second at 15.9 per cent. Our own TSX managed a 4 per cent gain, slightly ahead of the Dow Jones Industrial Average.
It was a better outcome than many analysts had predicted at the start of the year, but it was narrowly based. Technology stocks, which were hammered in 2022, rebounded strongly. Since Nasdaq is tech heavy, it was the main beneficiary.
It was the same with the S&P. The S&P 500 Information Technology Index was ahead about 40 per cent in the first half. According to a report on CNBC, the seven largest companies in the S&P, all tech, were up 86 per cent in the first half. The other 493 stocks more or less broke even.
That’s left some tech valuations looking uncomfortably high, especially in the context of what happened last year. Amazon’s p/e ratio was 309 at the time of writing. Nvidia was at 214. Tesla was at 74. Stocks like Alphabet (p/e of 26), Apple (32), Meta Platforms (35), and Microsoft (36) look cheap by comparison. They’re not. They’re just less unreasonable.
The upsurge in tech has been fueled almost entirely by the surge of artificial intelligence (AI). Companies like Alphabet and Microsoft have been working in this area for years, and AI is central to Tesla’s self-driving cars. But until recently most investors saw AI as an interesting idea for a future time. Suddenly, with ChatGPT, here and accessible, everyone wants in.
In that sense, we’re back in 1999-2000 territory, where any company that had a credible internet story could make millions on an IPO. Except that this time around, we’re not dealing with start-ups but giant international corporations with market caps north of a trillion dollars in some cases.
The sheer size of these giants makes the current situation less risky in the sense that none are liable to crash and burn. But if AI turns out to be just another bubble, the losses will still sting.
Exciting as AI might be, anyone allocating new money right now is probably better to look at sectors that have been beaten down over the past year.
One sector to consider is energy. After surging last year, the big oil companies have been market pariahs in 2023. The S&P/TSX Capped Energy Index down about 7 per cent since the end of December and some oil stocks have posted double-digit losses this year. That’s left some great companies looking very attractive.
Consider Canadian Natural Resources (CNQ-T), one of the country’s best managed and productive businesses. It has posted a small gain so far in 2023. You can now buy the stock at about 9x earnings and enjoy a dividend of 4.85 per cent. CNQ has raised the dividend twice in the past year.
Interest sensitive stocks also look attractive now and will be more so as rate increases wind down.
REITs are one example. The S&P/TSX Capped REIT Index took a big tumble in 2022 when the central banks began aggressively raising rates. After hitting a low in October of that year, the sector staged a modest rally. It’s now bumping along, going nowhere, with a year-to-date loss of about 1 per cent.
One of our Internet Wealth Builder recommendations, Boardwalk REIT (BEI.UN-T), has gained 25 per cent so far this year but still only shows a p/e ratio of 7.27. Minto Apartment REIT, an Income Investor recommendation, is even cheaper at 3.59x. It has gained about 6 per cent year-to-date and yields 3.2 per cent.
Other interest-sensitive sectors to watch include pipelines, telecoms, and utilities. All should start to turn higher when the rate tightening cycle ends, which should happen by year-end.
If we have a recession, stocks will take a temporary hit — how much will depend on the severity of the downturn. That’s when the cycle will turn. Central banks will start to cut rates again and the out-of-favour sectors I’ve mentioned will rebound.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.