RFM 2023 Top 5 – Sombre but sober

China Technology – The last shoe

• The worsening Covid situation in China continues to hurt sentiment towards Chinese technology but this looks to me like the other shoe dropping and a signalling of the bottom.
• Chinese technology has been hammered by regulation, geopolitics and the economic fallout from Covid zero and given how lowly it is valued, I suspect that all of this is priced in.
• However, spring inevitably follows winter and with the Chinese state having clearly abandoned Covid Zero, there is going to be a big bounce when the Chinese nation reaches herd immunity.
• This should happen much more quickly than it did in the West thanks to vaccines that are not as bad as everyone seems to think and a virus that is now much less lethal and much more transmissible than it was in 2020.
• Furthermore, the People’s Bank of China has space to cut interest rates to stimulate the economy if the CCP decides that exiting Covid zero is not enough stimulus on its own.
• A bounce in the economy will help the technology sector return to growth which combined with rock-bottom sentiment, leaves Chinese technology primed for a sharp recovery.
• This means that of all the technology sub-sectors, Chinese technology looks to me like it will be a big outperformer this year,

Crypto – Capitulation.

• Crypto is likely to go nowhere this year but there are a few interesting things to keep an eye on in 2023.
• Bitcoin is now priced not too far away from its cost of production meaning that there should be support if the price of the token halves yet again as some predict.
• That being said, there is no reason why it should suddenly rally back to $70,000+ either as it (and all cryptocurrencies) remain highly unsuitable as mediums of exchange and are nothing more than speculative assets.
• Consequently, I think Bitcoin et al, hover around current levels and have a pretty boring year as interest from speculators continues to decline.
• However, the blockchain technology has real-world use cases such as managing fractional ownership of indivisible and intangible assets such as patents and copyrights.
• Hence, there is a place for the blockchain, and I think some great companies will emerge from the wreckage although this may take a while.
• In the meantime, my colleague Will Nutting over at Nutstuff (see here) thinks that Coinbase 2028 bonds priced at $0.52 on the dollar with a yield of 14.5% are worth looking at.
• Having liked the company but hated the share price (see here), this is something I will be having a close look at.

Macro – No better but no worse.

• The adjustment to a world where one has to pay interest on one’s debts has been painful but there are signs that the transition is largely over.
• Central banks have almost no room to continue increasing rates given how much it will increase the interest bill payable on government debt across the world.
• Hence, real yields are likely to remain negative indicating that inflation will remain stubbornly high at somewhere between 6% and 8%.
• This means that in 2023, the macro-outlook will not deteriorate but I don’t think it is going to improve either.
• It is not until 2024 when the pandemic bill has largely been paid through inflation that inflation is likely to subside meaning real pay increases for consumers and a return of somewhat better economic times.
• Until then I think economies stagnate meaning that growth will be hard to come by and valuations will remain under pressure.
• This is why I think 2023 is going to be a stock pickers market and that hard assets and businesses with real cash flows will outperform blue sky narratives.

Automotive – The delayed chess game.

• The level of change in the automotive industry is likely to increase in 2023 but the real effects of this will not become visible for several years.
• This is because decisions and deals that are done today will start producing revenues in 2025 or 2026 at the earliest thanks to the 4 to 5-year design cycle that is how vehicles are designed and produced.
• The focus is also likely to move away from autonomous driving where sentiment has imploded as a result of the industry’s inability to get it to work properly.
• Attention is instead likely to be focused on the digitisation of the vehicle.
• This is being effected through software which is moving to become more centralised in the vehicle running on fewer chips but much more powerful ones.
• This is what allows the software to be updated over the air as well as integrated such that a decent digital experience can be delivered to vehicle occupants and monetised.
• The real battle for OEMs is to defend their vehicles against the smartphone invasion but their performance to date has been very disappointing.
• Hence, many OEMs are on a trajectory to become Android handset makers greatly reducing their ability to benefit from the extension of the digital ecosystem into the vehicle.
• This is not the future they or their investors envisage for themselves and so much needs to change if they are to avoid the fate of the Android handset makers.

Semiconductors – Supercycle continued.

• With no macro improvement and more supply coming on stream in 2023, the immediate outlook for semiconductors is not good.
• Many players have been hit particularly hard as inventory corrections have greatly exacerbated the demand decline they are experiencing.
• Semiconductor fabs are currently being built for geopolitical reasons and not in response to demand and still the output of these factories will have to be absorbed by the market when they come onstream.
• At the same time, I see China turning more towards the lagging edge meaning that supply at 45nm – 28nm may also jump upwards.
• Consequently, the impact of the capex splurge that has been experienced over the last couple of years has yet to be felt, and if it comes during 2023, then the cycle is likely to take another big leg down.
• Against this backdrop, one does not want to be holding the expensive end of the semiconductor sector nor the part of it that owns or is building capacity.
• This is why although TSMC and Samsung look very attractive from a valuation perspective, I prefer Qualcomm and MediaTek, both of whom have a similar valuation but own no factories.