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5 stocks safe from rising rates
The Fed didn't surprise anyone with its 12th straight rate hike. But with inflation looming and more rate increases all but certain, it's time to seek shelter.
By Jim Jubak
No surprises.
When the Federal Reserve finally raised short-term interest rates to 4% on Nov. 1, the move was exactly what the stock and bond markets had expected. The Federal Open Market Committee didn't even change its standing language: Monetary policy remains accommodative (that's Fed speak that means interest rates are still low enough to encourage economic growth), longer-term inflation expectations remain contained and interest rates will be raised at a measured pace.
On the non-news, the Treasury bond market rallied, the dollar moved slightly lower and stocks moved up from the negative territory that they'd occupied before the announcement.
Yep, nothing here like the nightmare scenarios that have kept the stock and bond markets on edge for most of October. No heightened warning about inflation. No speed-up in the pace of interest rate increases. No indication of panic or even heightened anxiety from the Fed.
A seasonal, and short, rally
But don't kid yourself. No surprises isn't the same as good news. Inflation is a potential problem: "The cumulative rise in energy and other costs have the potential to add to inflation pressures," the Fed said. And there's no sign that this interest rate increase or the almost dead-certain one coming at the Dec. 13 meeting is going to be the last increase either. The "smart money" is betting that the new Ben Bernanke-led Fed will want to show its inflation-fighting colors by raising rates at the March 28 meeting, whether or not Alan Greenspan raises interest rates at his farewell, the Jan. 31, 2006 meeting.
The latest interest rate increase may well be good for the financial markets in the short term. Since a 4% short-term rate was pretty much baked into stock and bond prices, the lack of any negative surprise could well lead investors to exhale in relief. With the season of rallies upon us, that sigh of relief could well be enough to spark a short-term rally.
More from MSN Money
Actually I think we're talking very short term. Any investor who looks out not two months but six months, as I do in these short-term picks for my weekly appearance on CNBC, has to notice that the November interest-rate increase hasn't put an end to the rate hike drama -- and that the drama is likely to get even more dramatic as we move into 2006 and witness the end of the Greenspan era.
And the drama isn't just on the interest-rate side. The Fed has raised the possibility that higher energy prices may increasingly seep over into a higher core rate of inflation. The Fed also has noted that because of Hurricanes Katrina, Rita and Wilma, recent data on economic growth, personal incomes, and employment arent especially reliable right now. The Fed would never put it this way, but the folks who are running U.S. monetary policy (and effectively running economic policy, too, given the abdication of responsibility by the President and Congress) are driving blind.
Time for safe stocks
So I think it's time for anyone thinking six months out or longer to think about sheltering part of their equity portfolio in stocks that provide the maximum in inflation and growth protection. The stocks I'm looking for provide protection from inflation because these companies have demonstrated an ability to pass cost increases to their customers without seeing a drop-off in sales or market share. And they provide growth protection since these companies sell products that consumers will continue to buy even if growth in the economy as a whole slows down.
In my Wednesday morning appearance on CNBC's "Morning Call," I picked three stocks that should prove inflation-proof and slowdown-proof.
Procter & Gamble (PG, news, msgs). With a few alterations, Procter & Gamble could adopt the old Post Office motto: Neither hurricanes, soaring energy prices, or higher raw material costs will delay this company from delivering better-than-projected earnings. The key was passing higher costs to customers without losing sales volume. In the quarter just reported on Oct. 31, higher commodity costs, for example, hurt gross profit margins by more than a full percentage point, but Procter & Gamble managed to recoup all but 0.2 percentage points of that by raising prices. Because of the strength of the company's product lineup, those price increases didn't cut sales -- sales grew 8% and unit volumes climbed 6%. Free cash flow (operating cash flow minus capital spending) hit $1.8 billion in the quarter. A consumer-staples company that can handle everything that this last quarter threw at it is a pretty good shelter from the potential economic storms of 2006. The stock trades at 20.7 times projected earnings for the fiscal year that ends in July 2006 and yields 2%. Our StockScouter rates these shares a 6 out of a possible 10.
Sysco (SYY, news, msgs). Sysco looks like it has turned the corner toward lower inflation a year or more ahead of the rest of the economy. Food inflation, which ran at 6% to 8% a year ago, has dropped to just 1% to 2%. Although the company can pass along higher food costs to customers, the lag between when costs go up and when customers start to pay higher prices made the last 12 months tough for Sysco and its stock, down 6% in that time. But with food inflation down -- and with the company able to much more readily pass along rising fuel costs in the form of a surcharge to customers -- the next 12 months look much brighter for the stock. The company's efforts to cut costs, a necessity when food inflation was so high, have resulted in permanent savings in transportation and inventory costs. The company has also geared up its growth plans with a goal of adding 3% to annual revenue through acquisitions in fiscal 2006 and 5% to 6% in organic sales growth from a larger and more aggressive sales force. It won't hurt the stock either that growth in the next 12 months will be compared to the weak results of the last 12 months. Wall Street now projects that earnings growth will climb to 14% in the fiscal year that ends in July 2007 from 5.2% in fiscal 2006. The shares trade at 19.7 times projected fiscal 2006 earnings per share. Our StockScouter rates these shares a 6 out of a possible 10.
Smithfield Foods (SFD, news, msgs). As one of the most integrated of meat companies, Smithfield Foods often winds up inflation neutral. When corn prices rise, that hurts margins in the pig-raising operation. But hog prices often climb at the same time, offsetting the corn costs. Occasionally everything goes the company's way, as it might have in the quarter to be reported on Nov. 30, with hog prices up and corn prices down. Over the next six months, I'll be content if the company just hangs in around inflation neutral and continues to grow sales at something like the 7% Wall Street expects for the year that ends in April. According to Zacks Investment Research, analysts are projecting 13% earnings growth for fiscal 2006. The stock trades at 9.8 times projected fiscal 2006 earnings per share. Our StockScouter rates the shares a 6 out of a possible 10.
As always, I have two more "exclusive" picks for readers of CNBC.com on MSN Money.
Pepsico (PEP, news, msgs). Pepsico isn't immune from the ravages of inflation. In the third quarter, for example, the company's Frito Lay North America unit grew sales by 6% but reported disappointing operating income as higher costs for commodities and marketing cut into margins. But Pepsico is such a growth machine right now that the company is able to make up for margin shortfalls in one division with better-than-expected top-line gains in another unit. For example, third-quarter sales of Gatorade and Aquafina, the company's non-carbonated flagships, picked up the slack with a 24% increase in sales. And the international division just keeps delivering -- 17% revenue growth in the third quarter -- as the company uses the one-two appeal of salty snacks and beverages to gain market share. Wall Street analysts project earnings growth of 11% in 2006, following 18% in 2005. The stock trades for 19.8 times projected 2006 earnings per share. Our StockScouter rates these shares a 6 out of a possible 10.
American International Group (AIG, news, msgs). Nothing like a few hurricanes to give an insurance company pricing power. Disasters like Katrina always shrink the pool of insurers -- as the weak companies either go under or stop writing policies under the weight of storm losses -- and produce higher prices as insurers raise premiums to make up for payouts. AIG, once the acknowledged class of the industry, has been tarnished by everything from fraudulent accounting to revelations of self-dealing and out-of-control executive pay. All that cost the company its coveted AAA rating. But the damage to the company's long-term business and to its balance sheet has been remarkably limited. In the second quarter, sales grew by 25% from the same period in 2004. AIG estimates that it will take a third-quarter loss of $1.1 billion due to Hurricane Katrina, or about 25 cents to 30 cents a share. (As a reminder that AIG isn't completely out of the woods yet, the company hasn't yet scheduled a date for reporting third quarter earnings.) Wall Street estimates that the company will earn $5.54 a share in 2006, so the shares are trading at just 11.8 times projected 2006 earnings. The stock has shown solid technical strength recently with the price climbing above both the 50-day and 200-day moving average early in October. Our StockScouter rates these shares a 7 out of a possible 10.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: American International Group and Pepsico. He doesn't own short positions in any stock mentioned in this column.
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