TNL - 3 Stocks To Buy As U.S. Inflation Stays Sticky

Summary

• The latest inflation numbers from the US at 6.4% YoY show disinflation is ongoing but more Fed rate hikes are likely too, increasing the chances of a recession.
• The three stocks selected here face lower than average inflation in their sectors, while being potentially insulated from a weak economy.
• While they are all good stocks/ADRs, they still target different risk levels from low to (relatively) high.

There was good news and bad news on the US inflation front for January 2023. While the figure came in at the lowest level since October 2021 of 6.4% on a year-on-year (YoY) basis, it was still above the expectation of a 6.2% increase. Further it came in at 0.5% on a seasonally adjusted month-on-month [MoM] as well, the highest level seen in three months.

Signs that inflation could prove sticky are also evident from core inflation figures, which is inflation ex-food and energy. It has declined slightly, from 5.7% last month, to the lowest level in a year (see chart below). But it has remained unchanged at 0.4% MoM. Core inflation is an indicator of longer-term trends, indicating that it could be some time before CPI increases are back to the Fed’s target rate of 2%.

Higher interest rates and recession risk

The key takeaway from the latest inflation data is that there the Fed could hike rates more than was earlier expected. This is especially so, when it is seen in conjunction with real indicators for the US economy. The labour market stays strong , as do the latest retail sales figures.

While acknowledging that the disinflationary process has begun in the US, Fed Chairman Jerome Powell recently cautioned that they are going to “react to data”, giving the example of strong labour market reports. Higher rates are already being pencilled in. Deutsche Bank has increased its US terminal rate forecast now to 5.6% from 5.1% earlier.

This is not good news. As the bank’s Macro Strategy team puts it in a recent note “These all support our base case for a recession rather than a soft landing.”, referring latest inflation data, the labour market numbers and the fact that financial conditions that have not tightened enough to meaningfully improve trends in the first two numbers. Even if we stay relatively optimistic, a slowdown is still expected. The IMF forecasts US growth to slow to 1.4% this year from 2% last year.

Stocks to buy now

The question now is, how should investors prepare themselves, if the outlook for the US economy stays muted. To zero down on stocks that can be good investing opportunities, I first considered segment wise inflation within the CPI index.

Within this, I focused on those that have witnessed inflation lower than the overall levels, which indicates that they could be better placed than others. Note that these are not the ones that are necessarily seeing a decline in inflation over time, but those whose inflation remains relatively muted. If companies in these segments just do not have pricing power, which reflects in inflation figures, that is not a positive, of course. But that is an analysis for company level data. Deflationary categories were removed from these, since they represent quite another can of worms, that can lead to a negative spiral for the sectors in question.

Three categories that stood out for me were apparel, medicine and recreation. Inflation for apparel is at 3.1% YoY. For medicine, a number of categories were considered, like medical drugs (3.2%), medical care services (3%) and hospital services (4%). Recreation services have an inflation of 5.8%.

But the challenge remained that even in a relatively low inflation environment, companies can still suffer if there is an economic slowdown. To address this, another layer of analysis was added. The focus is on companies in these segments with a substantial US market, and also have an inherent advantage that can protect them from a weak economy. Based on this, here are three stocks that can hold investors in good stead in the year ahead. Think of them as going from the lowest risk to the highest risk, giving a choice based on the appetite.

Go International: AstraZeneca

As far as medicine goes, AstraZeneca (NASDAQ: AZN ) has been one of my favourite stocks for a long time, for good reason. I believe that it is also the lowest risk one from a medium term perspective. The London headquartered biopharmaceuticals company recently released its full year results to rapid rise in price. The company’s ADR is now trading 8.2% compared to its price at close on the day before its earnings release last week. It continues to be positive on both revenue and earnings growth, which is particularly heartening at a time of expectations of a weak economy.

There’s more to like about it. As a global company, it is insulated from a recession in one part of the world, a risk of which is present in the US and the UK, where it is based. While the US is its biggest market with a 38% share in revenue to be sure, it also has the advantage of being a defensive. Its biggest segment is oncology, which underlines the critical nature of its treatments.

Further, its forward price-to-earnings (P/E) ratio at 24.8x is actually lower than that for the healthcare sector as a whole at 26.7x. As an aside, healthcare is a segment to consider in recessionary times in any case, because its growth and earnings are less likely to fluctuate at such times compared to more consumer oriented stocks.

Buy on Dip: LVMH Moët Hennessy

Arguably the biggest luxury fashion company in the world LVMH Moët Hennessy ( LVMUY ), is my pick for apparel, though the company is much more than that. Much like healthcare, it too is relatively cushioned from because it attracts the wealthy customer. Such stocks, and their underlying performances, are not immune to recessions, but they typically tend to bounce back fast . Still, it could be of some concern that the US and Europe, which account for half of its revenues, are expected to see a slowdown this year, with the risk of a recession in the US and UK and possibly Germany. At the same time, it can be supported by the pickup in China’s post-pandemic growth this year , since it is a big market for luxury goods.

With LVMH ADRs trading at all-time-highs this month, it does look a bit pricier than usual. At 29x, its P/E is higher than its own median value over the past 10 years at 24.3x . This coupled with the face that there could be some potential softening in growth if some of its key markets slow down, indicates the possibility of a dip in its price going into 2023. However, going by how sound the company is and the fact that its price has risen by no less than 393% over the past 10 years, would make it a great buy on dip.

Select Consumer Stocks: Travel + Leisure Co.

The closest it gets as a representative of recreation services segment as it is defined in the CPI, is Travel + Leisure Co. (TNL), which provides vacation ownership. It has an edge over the average stock in that international travel expected to inch closer towards pre-pandemic levels this year. This is especially so as the last of the pandemic fears seem to be behind us after a quiet winter season. Further, it is actually a near-luxury stock, given the exclusivity of vacation ownership.

Since its revenue is derived from memberships, it is predictable to the extent of 80% according to the company. Next, its financial performance is strong and its valuations are attractive, with a P/E of 9.9x. It is also still trading at almost 30% below its price at this time last year. It is a more speculative and highest risk pick compared to AZN and LVMUY, especially considering that its related segment, transportation services is seeing high inflation of 14.6%. It is also more likely to be impacted by a recession than the others, but for now it looks like a good buy nevertheless.

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