HDRO - 2023 Year-End Sector Review - Part 1

2024-01-04 11:15:00 ET

Summary

• In this 2023 year-end sector review (part 1), we look at how companies performed during 2023 in the communications services, consumer discretionary, consumer staples, energy, and financial services sectors.
• After a bad year in 2022, the consumer discretionary sector surged in 2023.
• We haven’t seen the worst of the story yet. I expect more pain to come in 2024 as we will feel the full consequences of the numerous rate hikes.

In this 2023 year-end sector review, part 1, we look at how companies performed during 2023 in the communications services, consumer discretionary, consumer staples, energy, and financial services sectors.

Communication Services

Communication services usually bring to mind big telecom companies like AT&T ( T ), Verizon ( VZ ), BCE ( BCE ), or Telus ( TU ). However, this sector has changed, now offering stocks from some technology firms. The sector is now fueled by companies like Alphabet (GOOG) ( GOOGL ), Meta (META) and Netflix (NFLX). Communication services now deliver growth through tech stocks and dividends through telecoms.

As depicted below, telco dividend stocks aren’t doing that well. Streaming services went from being darlings to garbage as the market realized it costs more than expected to produce entertaining content. After a difficult year in 2022, most tech-focused companies came back strong. Notably, Meta completely changed the market’s mind about its business model. Disney ( DIS ) just reinstated a small dividend, but still struggles to generate profit from its streaming services. It’ll be a long recovery.

In Canada, we saw BCE and Telus continue the downtrend started in 2022. They’re running out of time to prove their narrative - that investing massively over a decade to generate higher cash flow is worth the debt load. For 2024, my eyes will be fixed on their cash flow situation: cash from operations, capital expenditure and free cash flow. The goal is to cover dividend payments with free cash flow, i.e., the cash left over after investments in projects and network maintenance.

Consumer Discretionary

After a bad year in 2022, the consumer discretionary sector surged in 2023. Surprisingly, the consumer confidence index is a little higher than last year. However, we see that this confidence is fragile, fluctuating month by month, a sign that the average consumer isn’t sure about anything. Confidence and consumer spending can erode quickly.

Will we see a huge bump in 2024 if we hear about interest rate cuts? Possibly. Still, I’m not convinced we’ll have an economic soft landing and I continue to expect a recession. It will be hard to manage inflation and high interest rates for the Joneses.

Again, the U.S. ETF is dominated by Tesla and Amazon. I’m not sure I would give much importance to the sector uptrend at this point. Many retailers told us consumers are tightening their belts and going for essential spending way before rewarding themselves with treats.

Excluding these “big tech” companies, most consumer discretionary stocks have underperformed the index in 2023. It’s definitely a good time to select your favorite stock in this sector. Take your time and go for absolute winners, i.e., those with strong dividend triangles and several growth vectors.

In the latter part of 2023, we saw signs that higher interest rates are finally slowing down the economy. We’ll continue to feel their impact for many years. Unemployment rates remain low, but have a bit going up a bit lately on both sides of the border. Add inflation to the mix, which is slowing down but still adding pressure, and we might be in for a bumpy ride.

Consumer Staples

After a relatively flat year in 2022, consumer staples companies did a little worse in 2023. Inflation is hurting food producers, notably meat product producers, due to their margins contracting. Household & Personal products companies like Colgate-Palmolive (CL) and Procter & Gamble (PG) showed pricing power and some resiliency. Snacks and beverage are under pressure from weigh loss pills like Ozempic used by consumers to reduce their appetite and expected lower Doritos, Reese’s, and Coca-Cola consumption. Will that drop be permanent? I doubt it. It’s probably a good buying opportunity, though.

Boring is a dividend growth investor's best friend. In the consumer staples sector, you have the chance to find companies that march forward slowly, but surely. Inflation should be less of a concern for this sector, as consumers are willing to pay a higher price for basic goods. At the same time, do not expect to beat the market with these stocks. I’d be cautious about high yielders in this category. Tobacco stocks seem attractive, but their business model isn’t going anywhere.

Energy

If you’ve followed me for a while, you know I’m not a fan of the energy sector. My reason is simple: energy companies make money when commodity prices are up. They lose money when prices are down. They have no real control over prices. This makes them marginal dividend growers.

However, it is hard to ignore the impressive bull ride most energy stocks have been on in 2021-22. As you can see with the WTI crude oil spot price, the rise in price has been phenomenal.

Many companies reported strong earnings, plenty of cash flow, and lower debt levels. Does this change my opinion about this sector? Not really. I’ve seen this movie several times and I know how it ends. At the time of writing (December 2023), it was back between $70 and $75 per barrel. That’s a steep decline in a short time. The market remains confident as oil stocks still show great promise.

Will the narrative change if we see the price stabilizing under $80? We already saw some companies get hit by inflation (cost of exploration, labor, etc.). While the energy sector is a great shield against inflation, it also has to deal with the increased costs of their operations.

As for natural gas, we saw an important increase fueled by the Covid-hype and then by the war between Russia and Ukraine. The natural gas spot price is now back to 2019 levels. Moral of this story: the world adapts quicker than we think.

Financial Services

I alerted you that 2023 would be a year of higher and higher (and higher) interest rates. The Central Bank of Canada and the Fed are in it “for the kill” and the inflation will not survive (or our economy will perish). They rather amputate an arm to save the body. Fortunately for us, it seems we’re finally over the rate hikes.

Not long ago, we saw the first signs that the Consumer Price Index (CPI) was under control and that the economy was cooling off. The market got pretty happy, and everything grew in November. Don’t think we’re done yet. Will central banks reach their unachievable goal of a smooth landing? It’s clear that rate increases have a lagging effect on all economic metrics. Many homeowners and indebted companies haven’t renewed their mortgages or most of their debenture yet. We haven’t seen the worst of the story yet. I expect more pain to come in 2024 as we will feel the full consequences of the numerous rate hikes.

Stay tuned for part 2 of this sector review, where we’ll look at the healthcare, industrials, information technology, materials, REITs, and utilities sectors. Until then, stay invested!

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

For further details see: