Investing in the stock market can be a challenging task, especially when there are no guarantees. However, if interest rates remain high and the economy falters, there is a particular group of stocks that may stand out.
These stocks, known as "double beats with positive price action" by Wolfe Research, have shown remarkable performance. Not only did these companies exceed revenue and earnings expectations for the second and third quarters, but their stock prices also rose after the reports.
Wolfe Research suggests that these companies have a higher likelihood of outperforming their competitors as interest rates rise and the economic outlook weakens. Chief Investment Strategist Chris Senyek emphasizes that companies with high free-cash-flow yields are especially attractive in this scenario.
While Wolfe Research maintains a cautious outlook for the next six to 12 months, Senyek believes that inflation will persist longer than consensus estimates predict. This would give the Federal Reserve a reason to maintain higher interest rates for a more extended period than anticipated. Additionally, he expects the yield on 10-year U.S. government debt to surpass 5% by the end of the year, accompanied by sluggish economic growth.
Senyek expresses concern that these factors could ultimately lead to a "hard landing" for the U.S. economy in the first half of next year. Instead of reducing interest rates soon, he predicts that the Fed will adopt a policy of maintaining rates at a high level. This is due to the persistent and elevated nature of inflation.
Despite market expectations of rate reductions starting in May, there is even a possibility that the Fed could further raise rates, considering the 11 increases since March 2022. Senyek acknowledges that if inflation remains a challenge and the economy exhibits resilience, the Fed may find itself needing to hike rates again next year. However, he believes their base case is that the Fed is done for now.
In such uncertain times, it is essential for investors to carefully consider their options. Monitoring stocks that have demonstrated positive performance in the face of economic challenges could prove beneficial. While there may be no crystal balls in investing, strategic decision-making can help navigate through these uncertain waters.
High Rates and Slow Economic Growth: Identifying Stocks That Can Thrive
In a scenario characterized by high rates and sluggish economic growth, it is essential to identify stocks that have the potential to perform well. Wolfe Research has conducted a screening of S&P 500 companies and found over 50 stocks that show promise. These stocks consist of a combination of cyclicals and defensives, with the former flourishing during economic upswings and struggling in times of decline, while the latter are expected to remain resilient even during challenging periods.
Favoring certain sectors, Senyek, the expert behind the list of 50-plus stocks, suggests focusing on more defensive groups such as consumer staples, healthcare, and select technology companies. Senyek further advises narrowing down the list by considering companies with free-cash-flow yields of 4% or more. This metric, determined by dividing a company's free cash flow by its market capitalization, provides insight into how investors value the company's cash production. A higher free-cash-flow yield indicates that the company is positioned well to sustain or increase dividends and make capital investments.
Senyek emphasizes the significance of cash in today's market environment and highlights that companies generating above-market free-cash-flow yields are likely to utilize this cash wisely in the future. Whether it be through higher dividends, share buybacks, or debt repayments, these companies are expected to make positive moves.
Companies that meet both criteria of free-cash-flow yields and "double beats with positive price action" include Procter & Gamble (PG), Coca-Cola Company (KO), and Clorox (CLX) in the consumer staples sector, UnitedHealth Group (UNH) in healthcare, General Electric (GE) and 3M (MMM) in industrials, and F5 (FFIV) in technology.
While Amazon.com (AMZN), one of the renowned tech giants, managed to pass the initial stock screen, its free-cash-flow yield stands at a lower 1%. None of the other six major technology companies qualified in either area.
Investors are advised to look beyond the big seven tech stocks as Senyek suggests that the fundamentals of these companies are gradually weakening.