Two words are dominating the macroeconomic outlook at the moment. Neither of them is particularly positive. The first is ‘recession’. The second is ‘stagflation’.
A recession is a period of negative economic growth — usually at least two quarters. This is bad for investors as it generally means lower earnings from the companies whose shares they own.
Stagflation is defined as persistent high inflation during a period of weak economic growth. This is arguably worse, since it combines weak economic results with increasing prices.
With talk of both in the news, it’s tempting to try and take shelter in consumer defensive and utilities stocks. These businesses typically enjoy steady demand regardless of the macroeconomic climate, so should continue to turn in ok results even if economic activity is suppressed.
For my part, though, I’m taking a different approach. If we see stagflation and a recession, I plan to load up on quality companies that are likely to trade at depressed prices in the short term.
In other words, I’m following Warren Buffett’s advice to be greedy when others are fearful. As others move out of consumer cyclical stocks and industrials, I’m looking to take the opportunity to get involved.
This strategy carries risks — extended weak economic activity might cause prolonged underperformance. But if I can get it right, I think that there could be big rewards.
Consumer cyclicals
Consumer cyclical stocks are those that tend to perform better when economic activity is strong. When such activity is weaker, these stocks tend to perform less well, which I think might present me with some good opportunities.
In the UK, I’m looking at Howden Joinery Group. The company has a strong balance sheet and has held up well so far in an inflationary environment. Another stock on my radar is Burberry, which I think has good prospects for growth as it generates a lot of its revenues from the emerging affluent class in China.
In the US, I’m keeping a close eye on Amazon, which I view as a high-quality organisation, even if its e-commerce operations might face short-term headwinds. I’m also watching power sports company Polaris and housebuilder NVR closely as two companies I’d love to add to my portfolio.
Industrials
Industrial stocks tend to struggle in stagflation or recession. Companies in this sector experience lower demand for their products and their input costs can be higher in an inflationary environment.
Two UK stocks in the industrials sector that I rate highly are defence contractor BAE Systems and manufacturing company Renishaw. In both cases, I think that the share prices are higher than I’d like to pay, but I’ll be watching both carefully in case the macroeconomic backdrop moves these into more attractive territory.
Across the pond, I’m looking very closely at manufacturing company Graco and trucking company Landstar System. Both of these companies have more cash than debt and I think that they should prove resilient over time. If there’s a significant fall in the price of either, I’ll be looking to buy shares.
With stagflation and recession on the horizon, I’m looking to be bold — or greedy where others are fearful. This involves looking at sectors that are likely to have short-term difficulties and exploit any weakness in share prices.
