2023-03-07 07:15:00 ET
Summary
- Inflation might be reaccelerating and could potentially get stuck at 4% to 5% for years or even the next decade.
- Stocks are the best long-term inflation hedge, and historically four sectors, in particular, do best in high and rising inflation regimes.
- Here are four blue-chip bargains representing these four sectors, and each one offers 17% to 50% annual return potential through 2025.
- All four have highly adaptable management teams, good balance sheets, and stable cash flow that should make for generous, safe, and growing dividends in the coming years.
- Whatever inflation and the economy do next, buying these four inflation salvation high-yield blue chips is likely to make long-term investors thrilled in the next 5+ years.
This article was published on Dividend Kings on Monday, March 6th.
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Inflation was the driving force of 2022, and it might be for the next few months or possibly much longer.
Core inflation, which is what the Fed targets, appears stuck at 4.7%. The Cleveland Fed expects it to remain stuck at 4.7% in March and April.
Super Core inflation or services ex-housing is also elevated with no signs of declining.
In fact, for three consecutive months, Super Core inflation has been getting worse.
You might think inflation has to be coming down, given that commodities are now 10% lower than pre-invasion levels.
With China reopening from Covid-Zero and strengthening the European economy with it (its largest trading partner), it's possible that commodity prices start rising again.
However, 70% of the U.S. economy is services, and service inflation is primarily determined by wage growth.
This brings us to the tightest job market in 54 years, made worse by less immigration and increased retirements during the Pandemic.
This Friday is the January jobs report, and the consensus shows troubling signs that inflation might mean inflation remains stuck or even gets worse for a few months.
After a blowout 517K jobs growth last month, economists are expecting 208,000 this month. For context, Bloomberg estimates that just 30,000 monthly jobs are needed to keep up with population growth.
The NY Fed estimates its 125K, but either way unemployment is expected to stay 3.4%, the lowest since 1969.
Wage growth is expected to accelerate from 4.4% YOY to 4.8% and 4.9% annually.
The Fed and Moody's estimate 3.5% wage growth is consistent with 2% inflation.
And we can't forget there is one giant elephant in the room potentially driving higher inflation in the future, or at least increasing inflationary pressure.
The non-partisan Congressional Budget Office, or CBO, just released its latest long-term forecasts. They now expect $20.3 trillion in deficits over the next decade.
That's an average of $2 trillion per year (rising to $10 trillion by 2053), and deficit spending is stimulatory (inflationary) for the economy.
Not all of the deficit spending is inflationary, such as the $1.6 trillion in infrastructure spending (four bills) over the next decade.
- World Bank estimates this will boost GDP by $2.4 trillion or 1% per year.
The productivity boosts from infrastructure spending and AI (2% potential GDP growth boost according to Bank of America through 2030) could help control inflation.
But the point is that those hoping for a quick return to 2% inflation and, thus a fast Fed pivot might be very disappointed. We might be in a higher for longer inflation regime that lasts for years or even a decade.
Stocks That Offer Inflation Salvation
If you want to know what the best inflation hedges during a period of rising or high inflation are, historically, it's trend following managed futures. They historically run circles around commodity prices, including gold, as inflation hedges.
In fact, in the 1970s, when inflation averaged 7% and rose to 15% by 1981, managed futures delivered 22% annualized returns.
I've recommended several great mutual fund or exchange-traded fund ("ETF") ideas for this completely non-correlated (to stocks and bonds) asset class.
- Two 9+% Yielding ETFs I'm Buying And So Should You
- 3 Amazing Dividend Blue-Chips Beating This Bear Market
- Preparing For Recession Part 44: A Potentially Game-Changing 12.4% Yielding ETF For Your Ultra SWAN Portfolio .
However, these are just medium-term hedges against high-inflation regimes.
Long-term stocks are the best inflation hedge, offering 6.9% inflation-adjusted returns from 1900 to 2022.
- $1 invested in U.S. stocks in 1900 was worth $2,000 adjusted for inflation by 2022
- not adjusted for inflation, $1 turned into $70,000.
We're currently in a high and falling inflation regime when historically, stocks beat inflation 76% of the time, including the stagflation hell of the 1970s.
Even if inflation starts rising again, stocks still beat inflation about half the time.
OK, but surely some sectors must be better than others during high inflation environments, right? Yes, and not the ones you might think.
Historically, energy, equity real estate investment trusts ("REITs"), consumer staples, and utilities offer the best returns and the best inflation hedging power in a high and rising inflation regime.
But that doesn't mean you can buy just any names in these sectors. Remember, valuation matters a lot.
- Historically it drives 80% of total returns over the long-term.
Historically, or at least since 1900, the "rule of 20" has prevailed.
- the market's historical fair value forward P/E is 20 - the long-term inflation rate.
In other words, with the historical 3.2% inflation rate since 1900, the rule of 20 says the market should have averaged 20 - 3.2% or 16.8X forward P/E.
Guess what the 100-year, 45-year and 25-year average for U.S. stocks was? About 16.8.
- 17.9X right now
- factoring in a historically average recession (13% EPS decline), it's 21.5X.
A lot of historical inflation/recession defensive stocks, such as consumer staples, are trading at absurdly high valuations right now.
Why? Because long-only fund managers have to buy something, and we're likely headed for the most anticipated recession in history. And inflation is high.
So guess what fund managers are forced to buy? Stocks like Walmart Inc. ( WMT ) because it's the "safe" bet in the short term.
But smart investors who manage their own portfolios are able to buy companies that big fund managers can't, and that's what this article is all about.
4 Inflation Salvation High-Yield Blue Chips
Here are some top choices from the four best inflation-fighting sectors, energy, equity REITs, consumer staples, and utilities.
British American Tobacco p.l.c. ( BTI ): My Top Consumer Staples Recommendation (And 14% Of My Family's Hedge Fund)
Further Reading
Summary Facts
- DK quality rating: 93% very low risk 13/13 Ultra SWAN (sleep-well-at-night) global aristocrat
- Fair value: $63.30
- Current price: $38.04
- Historical discount: 40%
- DK rating: potential Ultra Value Buffett-style table-pounding buy
- Yield: 7.4%
- Long-term growth consensus: 9.1%
- Long-term total return potential: 16.5%.
Magellan Midstream Partners, L.P. ( MMP )(Uses K1 Tax Form): A Great High-Yield Energy Choice
Further Reading
Summary Facts
- DK quality rating: 98% high risk 13/13 blue-chip midstream
- Fair value: $67.94
- Current price: $53.88
- Historical discount: 20%
- DK rating: potential strong buy
- Yield: 7.8%
- Long-term growth consensus: 5.9%
- Long-term total return potential: 13.7%.
Kilroy Realty Corporation ( KRC ): A Deep Value Speculative Ultra-Yield REIT
Further Reading
Summary Facts
- DK quality rating: 81% low risk 13/13 speculative blue-chip REIT
- Fair value: $81.88
- Current price: $36.71
- Historical discount: 55%
- DK rating: potential speculative ultra-value buy
- Yield: 5.9%
- Long-term growth consensus: 1.8%
- Long-term total return potential: 7.8% (sell at fair value if growth outlook doesn't improve).
If KRC's growth outlook doesn't recover in the coming years, I would recommend selling at fair value.
- 17% to 19% CAGR total return range for the next five years.
NextEra Energy Partners, LP ( NEP ) (No K1)
Further Reading
Summary Facts
- DK quality rating: 84% medium risk 11/13 blue-chip yieldCo
- Fair value: $85.55
- Current price: $66.58
- Historical discount: 22%
- DK rating: potential good buy
- Yield: 4.9%
- Long-term growth consensus: 15%
- Long-term total return potential: 19.9%.
Bottom Line: These 4 Inflation-Salvation High-Yield Blue Chips Can Help You Beat Inflation In 2023 And Far Beyond
Let me be clear: I'm NOT calling the bottom in MMP, KRC, BTI, or NEP (I'm not a market-timer).
Not even 13/13 Ultra SWAN quality does NOT mean "can't fall hard and fast in a bear market."
Fundamentals are all that determine safety and quality, and my recommendations.
- over 30+ years, 97% of stock returns are a function of pure fundamentals, not luck
- in the short term; luck is 25X as powerful as fundamentals
- in the long term, fundamentals are 33X as powerful as luck.
While I can't predict the market in the short term, here's what I can tell you about these high-yield blue-chips.
They represent four very high-quality companies with great businesses, solid and adaptable management, and the balance sheets to ride out the coming recession.
And if we end up with higher inflation for longer? Well, they will likely be just fine, and likely will outperform the broader market, likely by a lot.
I can't tell you when this bear market will end, but I can tell you that if you're not buying blue-chip bargains during this bear market, you'll eventually regret it.
For further details see:
4 Inflation Salvation High-Yield Blue-Chip Bargain Buys