Against a backdrop of negative “real rates,” it pays to buy quality stocks such as Apple.
Angela Weiss/AFP/Getty Images
Is the era of easy money over? If investors didn’t believe it before this past week, they should now.
Technically speaking, easy money is when yields on ultrasafe bonds are lower than inflation, either actual or expected. Practically speaking, these negative “real rates” mean there’s so much cash in the system that anybody with a PowerPoint presentation and a dream can get funding. Easy money also means investors focused on cash preservation are actually losing wealth.
Real rates had been below zero more than 80% of the time from just before the 2008-09 financial crisis through the end of 2021. Then inflation took off, the Federal Reserve started tightening, and now real rates are positive. Investors have been reluctant to believe they’ll stay that way—the market had been pricing in rate cuts at some point in 2023—but this past week’s inflation data and comments from Fed members suggest that they’re going to have to stay positive for a long time. Easy money? “That’s over,” says Joe Quinlan, head of market strategy at Bank of America’s chief investment office.
Investors steeped in a lower-forever interest-rate paradigm will have to adjust. Fortunately, there is a way to do that—buying shares of companies with stable businesses and low debt loads, otherwise known as quality stocks. Investors have been hearing “buy quality” for a while, but it never hurts to get reminded, particularly after a 13-year period when the growth-oriented Nasdaq Composite’s return doubled that of the sleepier Dow Jones Industrial Average. The temptation might be to go back to what worked before.
For Quinlan, “buy quality” means owning stocks of companies that can grow earnings, pay dividends, have substantial, stable cash flow, and operate in an industry with some secular growth. He likes defense stocks, which have the cash flows and the dividends, and should also get a boost as defense budgets head higher in the U.S. and Europe.
Fundstrat head of global portfolio strategy Brian Rauscher recommends established technology stocks that generate cash flow. Think
Apple
(ticker: AAPL). It generated about $111 billion in free cash flow in its 2022 fiscal year, paying out roughly $15 billion in dividends while buying back almost $90 billion worth of stock. He also likes healthcare equipment names, including
Stryker
(SYK), which makes hip and knee replacements, among other things. It generated about $2.5 billion in free cash flow a year on average for the past three years, and is expected to average about $3.8 billion a year over the coming three years.
The one downside to quality stocks: their valuations. They tend to be higher than junkier companies, and rising rates, as we know, can depress stock market valuations. Quinlan, though, doesn’t think that will be a problem because companies with growth and the pricing power to maintain or expand margins should see valuations hold up.
They might even deserve them.
Write to Al Root at allen.root@dowjones.com
Credit: marketwatch.com