As the economy faces uncertainties and interest rates remain higher, there is a group of stocks that stands out. Referred to as “double beats with positive price action” by Wolfe Research, these companies not only exceeded revenue and earnings expectations in the second and third quarters but also saw their stock prices rise following these reports.
Wolfe Research believes that these companies have a higher chance of outperforming their peers as interest rates increase and the economic outlook softens. Chief Investment Strategist Chris Senyek highlights that companies with high free-cash-flow yields are particularly appealing.
Cautious Outlook for the Future
Looking ahead, Wolfe Research has a cautious outlook for the next six to 12 months. Senyek anticipates that inflation will persist longer than the consensus estimates, leading the Federal Reserve to maintain higher interest rates for a longer period than originally anticipated. Additionally, Wolfe Research expects the yield on 10-year U.S. government debt to surpass 5% by the end of the year, while economic growth is predicted to be sluggish.
Hard Landing for the U.S. Economy?
Providing further insights, Senyek suggests that the cumulative impact of Fed rate hikes and higher interest rates will likely result in a hard landing for the U.S. economy in the first half of next year.
A Different Approach for the Federal Reserve
Rather than implementing rate cuts, Senyek believes that the Federal Reserve is more likely to adopt a “high and hold” policy. He highlights that historically, the Fed has cut interest rates six to nine months after the last rate hike. However, this time, Senyek argues that there is a higher threshold for rate cuts due to elevated and persistent inflation.
Potential for Rate Increases?
Despite market expectations of rate reductions starting in May, there is even a possibility that the Fed could raise rates again. Senyek points out that the central bank has already increased the fed-funds rate target from near zero to 5.25%-5.50% through 11 hikes since March 2022. He acknowledges that if inflation remains stubborn and the economy remains resilient, the Fed might be compelled to raise rates again next year. However, Senyek’s base case is that the Fed is done raising rates for now.
In a time of economic uncertainty and heightened interest rates, these “double beats with positive price action” stocks offer an opportunity for investors to consider as they navigate the road ahead.
Picking Winners in a Challenging Market: The Top Stocks to Watch
In a market characterized by high rates and slow economic growth, identifying stocks that have the potential to perform well can be a daunting task. However, Wolfe Research has conducted a thorough screening of S&P 500 companies and found over 50 promising contenders. These stocks consist of a mix of cyclicals, which thrive during economic upticks but struggle in downturns, as well as defensives that are known for their ability to weather hard times.
According to experts at Wolfe Research, certain sectors stand out among the list of 50-plus stocks. To further narrow down the selection, they recommend focusing on defensive groups such as consumer staples, healthcare, and technology.
Another crucial factor to consider is the free-cash-flow yield, which indicates how a company’s cash production is valued by investors. To ensure stability and growth, companies with a free-cash-flow yield of 4% or higher are particularly appealing. A high free-cash-flow yield suggests that a company has the capacity to maintain or increase its dividend, as well as invest in capital expansion.
In today’s market environment, cash is king, emphasizes Wolfe Research’s experts. Companies with above-market free-cash-flow yields are poised to make positive moves with their cash reserves, whether it be through higher dividends, share buybacks, or debt repayments.
Following these criteria, certain companies have emerged as top contenders. In the consumer staples sector, Procter & Gamble (PG), Coca-Cola Company (KO), and Clorox (CLX) have all demonstrated strong free-cash-flow yields. UnitedHealth Group (UNH) has stood out in the healthcare sector, while General Electric (GE) and 3M (MMM) have shown promise in the industrials sector. Lastly, F5 (FFIV) has demonstrated potential in the technology sector.
Interestingly, while Amazon.com (AMZN) passed the initial stock screen, its free-cash-flow yield is only 1%, rendering it less attractive compared to other contenders. According to experts, it is essential for investors to look beyond the dominant seven tech stocks, as the fundamentals of these companies may be weakening.
In a challenging market, thorough analysis and careful consideration are key to identifying promising stocks. By focusing on defensive sectors and companies with strong free-cash-flow yields, investors can position themselves for success.