2023: A Year To Buy Yield And Sell Tech

In 2023, the opportunities for investors seeking yield are better than any in recent memory. In 2022, we got a preview of this situation, as the markets slid, driven by low-or-no yield tech stocks. This made high yield stocks more attractive compared to themselves in the past. However, tech stocks crashed even harder than high yield sectors like banking that year, while energy stocks rallied. In the latter half of 2022, you wanted to be buying tech.

That was then, this is now.

In the first half of 2023, tech stocks went on a large rally, with the NASDAQ-100 at one point up 45% for the year. The rally was driven by a mix of factors, most notably the wildly successful launch of ChatGPT in November 2022, and some investors starting to sense that tech stocks were getting undervalued. Tech stocks were indeed worth buying in late 2022–I used that period to load up on Apple (AAPL) shares among other things.

However, the NASDAQ-100 is currently trading at 30 times earnings. Its largest component, Apple, just put out a release that showed negative revenue growth. It’s hard not to feel like tech stocks have gotten a little bit overpriced at this point. Granted, a few of them have returned to their previous high growth ways, but it’s far from the entire group. On the whole, the NASDAQ-100 stocks are not giving investors the growth they used to expect.

Fortunately, that’s not really an issue, because there’s another segment of the market offering up bargains a-plenty: high yield!

High yield investments, including treasuries, corporate bonds and dividend stocks, currently offer the best yields they’ve had in years. Such stocks have fared poorly this year, mainly because of the Spring banking crisis and investors rotating into tech. To be sure, there was good reason to be concerned about banks for a while, but the situation has improved. None of the big four banks have collapsed, some are even gaining depositors. Still, many banks trade at depressed valuations. The liquidity issue with banks remains a very real one–if treasuries climb even higher, then banks’ CDs will have to match the ever-higher yields, lest they suffer deposit flight, of the sort that sank Silicon Valley Bank and First Republic. Fortunately, there are many ways to invest in high yield loan portfolios without assuming the liquidity risk of banks–non-bank lenders, mortgage REITs, and more. In this article I will explore the enormous opportunities now present in such sectors, highlighting the many virtues that they offer today, along with some downsides.

Dividends Rise as Stock Prices Fall

One of the reasons I’m so excited about high yield stocks right now is because in many cases their dividends are rising as their stock prices fall. This effect is being seen in many high yield sectors, but it’s nowhere more pronounced than in financials. According to Reuters, the top 4 banks all raised their dividends this year after passing the Fed’s stress test. Nevertheless, they as a group are down for the year. Some individual names, like Bank of America (BAC), are down over 10%!

Now, there are reasons for investors to be concerned about banks. As we all saw this past Spring with Silicon Valley Bank and First Republic, banks can collapse if too many depositors withdraw their money all at once and the banks are left with too little liquidity. As I showed in a recent article, Bank of America and most other large banks have more than enough liquidity to survive a crisis, although the presence of “unrealized losses” on their balance sheets has got people worrying about them more than is necessary. I personally think that when you look at the capital and liquidity ratios of the large banks, it becomes clear that most of them aren’t in clear and present danger. For example, BAC’s CET1 ratio is 11.6%, and it has enough highly liquid assets to cover 52.5% of deposits. Nevertheless, if you’re worried about the big banks, you still have plenty of high yield opportunities available to you in other sectors for which liquidity is not such a pressing concern.

For example, non-bank lenders. These companies lend money just like banks do, only they do not take deposits. Instead, they simply issue bonds with terms to maturity comparable to the loans they underwrite, capturing a spread between their cost and their borrowers’ cost. This is possible if the lender has high creditworthiness and the borrower is thought to have low creditworthiness. Of course, the perceived low creditworthiness of the borrower means that the loans are riskier, but an experienced team of credit analysts can find opportunities that are not too risky.

Consider Oaktree Specialty Lending (OCSL), for example. It currently has an 11% dividend yield. It recently issued a 7% yielding bond to help pay for its upcoming investments. The 7% yield on the bond means that the company will be able to capture a decent spread, if it can continue lending at the rates it has been.

Now, you might be thinking, “sure, Oaktree has a high yield portfolio, but what happens when the borrowers start defaulting? Some economists still think we’re headed for a recession, would it be wise to dismiss such a broad consensus as this?”

Perhaps not, but you must remember that the “devastating” effects of recessions on lenders depend on the severity of the recession in question. Mild recessions are usually fairly tolerable for lenders; it’s not until people get laid off and companies start going out of business that defaults become commonplace. As of the most recent reports, the job market remains strong and bankruptcies remain below pre-pandemic levels. All signs point to either no recession, or a mild one. This raises the possibility of lenders like OCSL being very enticing buys today.

If we assume that OCSL’s bankruptcies remain within a manageable level, then you’re paying a mere 8.2 times earnings, and precisely book value, for an enterprise that:

• Has grown its revenue at 20% CAGR over the last five years.

• Grew its revenue 35% in the trailing 12 month period.

• Grew its free cash flow 183% in the TTM period.

• Has a 24% net margin and a 21% free cash flow margin.

• Has an excellent 3.98 current ratio and a “reasonable” 1.22 debt/equity ratio (calculated from the balance sheet).

As we can see clearly from its recent financial statements, OCSL has excellent growth and profitability, yet its stock remains very cheap. This looks like one of those situations in which buyers are likely to be rewarded in the future.

Opportunities Outside Financials

Although my personal favorite high yield opportunities right now are in financials, there are many high yield opportunities elsewhere in the market.

The utility sector has a whole trades at 20 times earnings, which is below its five year average P/E of 26.

It’s a similar story with some utility stocks: Exxon (XOM) is at 10.3 times earnings despite oil prices having risen this year. Pipeline stocks with yields approaching 8% can be found. It’s the same story with telecommunication stocks.

Although the points I raised in this article apply most clearly to financials, the truth is that value stocks as a whole have gotten more appealing relative to tech stocks this year. The Dow is up only 2.9% this year, while the NASDAQ-100 is up 39.5%. Telcos have crashed to the point where some of them have single digit P/E ratios, and the Dow is now down to just 14.8 times earnings! There are many good reasons to explore value stocks in November of 2023. The stocks mentioned in this article serve as a good starting point for those hunting, the opportunities are unlimited.