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How to Invest in 2023’s Uncertain Market

This strategy can limit downside risk and boost investor confidence.

How to Invest in 2023’s Uncertain Market

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Every Monday morning, I sit down with Morningstar chief U.S. market strategist Dave Sekera to discuss the week ahead, but this week we’re doing something a little different. We’re breaking format and changing location to discuss one broad topic, and that’s how to invest in an uncertain market.

Dave, markets by their very nature are uncertain. But given the market environment that we’re in, facing still-high inflation, rising interest rates, and of course the threat of a recession, it seems like investors are facing quite a bit of uncertainty today. How should they be dealing with that? Is all that just noise that long-term investors should be ignoring?

Dave Sekera: Susan, one of the hardest things I’ve always found in investing is really differentiating the difference between noise, which of course as an investor you should ignore, and what is signal? And even when you identify signal change, what should you do with that signal change and whether or not you really should be changing your asset allocations? And so as an investor, I think first of all you should always have that balance in your asset allocation. Then that balance really as far as what your long-term goals are and what your risk tolerance is.

But then within that, I do think you can use those signal changes to help think about how you may want to be able to overweight or underweight certain aspects of your portfolio. And one of the ways that I really recommend investors to think about that is looking for different long-term structural trends and being able to identify those trends and invest in those trends, and that really is going to help you keep that long-term focus through, whether it’s just noise in the market or even a signal change.

Dziubinski: So let’s delve a little bit into that. You recently wrote about this a little bit on morningstar.com. And you laid out a strategy in the face of uncertainty that’s two-pronged, or has two parts. The first part is favoring undervalued stocks, so let’s start there. Why is that especially important in a volatile market when you’re facing an uncertain economic environment?

Sekera: Investing success, and especially if you’re investing in individual stocks, really always comes down to two things. One, it’s really identifying those high-quality companies that you want to be invested in, but then also making sure that you’re buying them at the right price. Even like the fastest-growing company out there, if you’re overpaying for it, it might be a great company, it might be growing fast, but you’re not going to end up making very good returns on it over time.

In fact, looking at some of Warren Buffett’s quotes in some of his shareholder letters over time, the one that sticks out to me here is, “In the short run, the market is a voting machine, but in the long run it’s a weighing machine.” So when I think about what that really means is that, in the short run, stocks can deviate quite a bit from their intrinsic value just based on the popularity, maybe the sentiment of the stock, or maybe the sector that it’s in. But over the long term, it’s always going to come back to what that true intrinsic value is. What is the value of that company based on its long-term cash flows?

Dziubinski: The second part of your strategy, after considering valuation, is to really favor those undervalued stocks that are tied to long-term growth themes. So outline what are the benefits of this two-part approach when it comes to stock investing in an uncertain market?

Sekera: There’s a couple things that I think about in that aspect. First is, I do think it helps limit your downside in the short term. So again, if it is tied to that secular theme, even in a recession or the economy softening, I would think that it should trade down less because, again, some of those sales tied to that long-term trend will still continue to keep moving upward. Second of all, I think it helps provide fortitude. As an investor, one of the worst things is you spend the time, you do your research, you find a company that you think is good to invest in, it’s at the right price. You pull the trigger, buy the stock, and then it starts trading down.

So again, I think by being involved in a long-term secular trend, that helps provide you that wherewithal that you need to make sure that you can hold that stock during a downturn and not sell into a panic selloff. And then lastly, I do think it also provides a lot of confidence as an investor. And so when you do enter one of these time periods that you do see that stock selling off, I think that gives you the confidence to not only be able to hold that stock through the selloff, but actually be able to go and buy more and take advantage of those market downturns.

Dziubinski: Let’s talk a little bit about some of the growth themes that you’ve been paying attention to, Dave, starting with this move toward electrical vehicles. Tell us about that theme.

Sekera: According to our analytical team, we think that by 2030, two thirds of all new global auto production will be electrified, whether that’s a battery electric vehicle or whether that’s a hybrid vehicle. And there’s a lot of different ways to invest in that. First of all, there’s the automakers in and of themselves. Yes, some of them may be undervalued today, but that’s a really competitive space. It doesn’t lend itself to economic moats. And so when I think about investing in that space, I’m looking really at a lot of those commodities, a lot of those components that are then used in order to be able to build the electric vehicles. And I think a lot of those are much more interesting. For example, during the gold rush, it wasn’t always the prospectors that got rich, but the people who did very well over time were the ones that sold the picks and the shovels that were used by the prospectors.

Dziubinski: Let’s talk about some companies that stand to benefit from this particular growth theme—ideas that you think investors should have on that watch list if they’re able to get the stocks at some point below fair value or when they’re undervalued.

Sekera: Well, one you and I have talked about a couple times in the past is certainly lithium. And as our analytical team did the analysis on the number of autos, they also determined, well, how much lithium is going to need in order to produce all those batteries that they’re going to need for those vehicles? And so based on the amount of lithium being mined today and the amount that they see coming out of production over time, we think lithium is going to be undersupplied for the next decade. So a couple companies that I would highlight there, Lithium Americas LAC is one, Livent LTHM is another, Albemarle ALB also. Those would be companies that I would take a look at that I think will be interesting in that space.

Next one is going to be specialty chemicals. Again, it takes anywhere from two and a half to three times as many specialty chemicals to make an electric vehicle as it does for a vehicle with an internal combustion engine. Two companies I would highlight there are going to be Celanese CE and Eastman Kodak KODK.

And then lastly, the parts. Again, a lot of the auto-parts manufacturers have been switching up their portfolio to those types of parts that are needed in EVs. And I know one that our analytical team thinks has a really good lineup is going to be BorgWarner BWA.

Dziubinski: Let’s talk about another theme that you’ve identified, is medtech. What is that?

Sekera: Medtech is going to be a combination of a lot of different things, but just generally I look at it from two points of view. One, we do have the baby boomer generation is continuing to get older. Needs a lot more services, a lot more healthcare. But a lot of advances in technology are not only being used in the electronics part of the world, but they’re applying those now into the different parts of the healthcare world. And so I think that’s one area that we do see a lot of upside over time. Thinking about things like liquid biopsies. That’s one where I would give an example there where there are companies who are looking at being able to use one blood draw in order to be able to prescreen for cancer, and in some cases up to 50 different types of cancers using that one blood screen. And I think that’s going to revolutionize the treatment of cancer because at that point not only would you be able to detect that cancer but you’re detecting it much earlier than you would have otherwise. And of course, that early detection then also has a better prognosis for treatment and better outcomes.

Dziubinski: Dave, is there a company or two in the medtech field that you like, again, if it can be bought at the right price?

Sekera: Yeah. The one that I would highlight there is Illumina ILMN. That’s one where they are currently testing some liquid biopsy products today. And I know that our analytical team thinks very highly of them. And so we’re waiting to see some of those test results. But I do think that that’s one where we really could see a huge total addressable market.

Dziubinski: And then the last thing we’ll talk about today is cybersecurity.

Sekera: Yeah. And again, just thinking about everything that’s going on in the world today, heightened global tensions, the geopolitics, but even things, just the cybercrime in and of itself. More ransomware attacks. This is just one space where you’re always going to have that battle going forward between companies trying to protect themselves and criminals trying to take advantage of it. And so I do see this as an industry that does have some long-term secular growth themes there. And I think it’s also got really attractive industry dynamics.

When you look at cybersecurity, that spending is actually a relatively small percentage of the budget for IT for most companies. But yet for a company that succumbs to some sort of cyberattack, that has huge costs both monetarily as well as reputationally. That is one of those areas that I just don’t see management, even in a recession or a downturn, willing in order to cut costs in that area.

Dziubinski: What would be a stock or stocks to watch on this front?

Sekera: Two that I can think of offhand that do have wide economic moats would be Fortinet FTNT and the other one is Palo Alto PANW.

Dziubinski: Thanks for your time this morning, Dave.

Be sure to join us again live on YouTube next Monday at 9 a.m. Eastern, 8 a.m. Central. And while you’re at it, subscribe to Morningstar’s channel. Have a great week.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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