The stock market could reach new lows in the new year, but there are some stocks where investors can weather market volatility, according to MKM Partners. Many of the forces that have weighed on stocks in 2022 will remain in 2023, at least in the first half of the year. That includes economic uncertainty in the wake of aggressive rate hikes from the Federal Reserve to tame high inflation. “As 2023 unfolds, we expect the economy to weaken under the weight of restrictive monetary policy and the ongoing diminution of excess liquidity,” said Michael Darda, MKM’s chief economist and market strategist. “A ‘restrictive and hold’ policy by the Fed could trigger a deeper than expected downturn.” That doesn’t bode well for stocks and means there’s a high risk that the equity market will see a new low next year, he said. Generally, markets tend to bottom about two-thirds of the way through a recession, not before they begin, according to the note. In that market environment, MKM recommends focusing on stocks that are defensive and avoiding sectors trading at high-cyclical adjusted valuations. The firm put together a list of its top picks where investors can find safety as they should withstand the volatility in the first half of next year. The top picks One of the top picks in food and beverage for MKM is Walmart, which it sees as poised to outperform peers and gain in 2023. “Walmart is gaining share against grocery peers, but discretionary categories have been soft,” analyst Bill Kirk wrote. Still, there’s the potential for upside for Walmart due to its dominance. He also expects the company to report a fourth-quarter 2022 earnings beat early in the year and guide above competitors for the rest of 2023. “Strong price gaps, an increased focus on price, and an increasingly value-seeking consumer should lead to continued market share gains for Walmart,” he said. “With less cost and inventory pressures, profitability should improve further.” A choppy economic backdrop is usually a negative for most companies, but it could be positive for O’Reilly Automotive, another top pick for MKM. “Lingering pressures on spending have historically pushed consumers to hold onto their vehicles longer and make repairs themselves out of economic necessity,” wrote analyst David Bellinger. “In our view, O’Reilly should continue its push towards $40+ in earnings power amid more programmatic buybacks. In the insurance sector, MKM’s top pick is Arch Capital Group . “Arch Capital Group remains our top pick as it is the most levered (Re)Insurer in the U.S. to higher rates as the company’s cycle management strategy had it withdraw capacity when rates were lower and moved aggressively back in when rates started up in late 2018,” wrote Harry Fong. MKM sees investors overlooking the amount of leverage that Arch has as a positive going into the current cycle. The firm thinks Arch is close to improving earnings and that the outlook loos positive. “Some investors continue to penalize the company for being in the mortgage insurance business,” Fong said. “However, the company has pulled capital out of the mortgage insurance business (not its core business) with some of it going into the P & C business.” The pick with the largest potential upside is Talos Energy , which MKM sees surging 47% to its target price. “We view it as the most catalyst-rich name in the sector, and it is one of the oilier names with a greater than 70% oil cut,” said analyst Leo Mariani. “We also expect the company will benefit from the increase in its market capitalization to above $2bn and modest deleveraging after the close of its merger with EnVen Energy which should allow more investors to own it. In addition, Talos Energy is the only E & P stock involved in carbon capture where that business is priced as a free option for investors, according to MKM. That success in 2023 should lead to some multiple expansion, they said. The last of the top five on the list is World Wrestling Entertainment, which has a more than 22% upside to MKM’s price target. That’s due to the growth opportunities present for the company. While the upcoming U.S. TV rights negotiations for Raw and Smackdown are the most significant catalysts, MKM sees other meaningful events such as international expansion, improved brand monetization, digital and web monetization and potential mergers and acquisitions. — CNBC’s Michael Bloom contributed reporting.
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