Here's What You Need To Know About Investing Now-And During A Slowdown

Recession forecasts for the middle of 2023 were widespread last year. In recent months, stronger-than-anticipated economic indicators indicating a booming U.S. labor market and robust consumer spending have calmed that attitude.

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As concerns about a recession subsided and traders placed bets that the Federal Reserve would stop raising interest rates, stocks rose. The parts of the market that were riskier and more speculative did the best.

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Despite all the optimism, expecting inflation to drop back to 2%, the GDP to keep growing faster than 2%, and the Fed to decrease interest rates are probably unrealistic expectations. Robert Phipps, director of Texas' Per Stirling Capital Management, compares it to "landing a Boeing 747 on an aircraft carrier" in terms of monetary policy.

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Investors should prepare for faster growth in the foreseeable future along with increased inflation and interest rates. Although it will increase their expenses, this should help cyclical enterprises' revenue grow longer than most predicted last year.

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Businesses that can leverage pricing power to pass on higher expenses to customers would benefit. Only about one in five S&P 500 firms managed to enhance their operating margin from the previous and year-ago quarters during the recent fourth-quarter earnings season. According toTrade Algo, they include cyclical businesses including United Rentals URI -0.24% (ticker: URI), Deere (DE), Honeywell International HON -2.04% (HON), Delta Air Lines (DAL), Linde (LIN), Schlumberger (SLB), and Wynn Resorts (WYNN).

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But, a rising economic tide that boosts the earnings of most businesses won't persist forever. Prepare to switch to growth stocks when the economy slows.

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Despite a weakening economy, technology and growth shares were last year's greatest losers, trailing cyclical sectors like energy. Growth enterprises were negatively impacted by sudden increases in interest rates since future cash flows are worth less discounted back to the present.

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Before stopping, the Fed may make a few more quarter-point increases, but the amount of change won't be as significant as it was in 2022. Growth stocks may so come back into favor as a result.

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Yet, the backdrop of higher rates for longer means that it won't be only about the "growth at all costs" businesses whose stocks did well in the decade prior to the Covid-19 outbreak. Because raising capital is more expensive, cost control and earnings are more crucial.

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Be prepared to invest in businesses that have fair values, noncyclical growth, near-term earnings, and strong balance sheets that indicate they won't require access to the capital markets for financing.

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Robert Stimpson, co-chief investment officer at Ohio-based Oak Associates, uses Alphabet, the parent company of Google, as an illustration. GOOGL -2.27% (GOOGL). The stock dropped 39% in value in 2022 and has lagged behind its peers in 2023 due to worries about chatbot competition for its dominant search engine.

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As a result, shares are currently selling at a multiple of about 17 times anticipated earnings for the upcoming year, which is the lowest it has been since 2013 and lower than the average multiple of over 25 times during the previous five years. Also, it is less than the S&P 500SPX -1.52%'s 19 times projected price/earnings multiple and its megacap tech rivals' multiples.

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Concerns concerning ChatGPT, a well-known chatbot with artificial intelligence, are dismissed by Stimpson. "[Alphabet is] also investing in AI and will compete with Microsoft [MSFT] and the others," he claims. "In the meantime, [Alphabet] gets a lot of income and free cash flow from the core search business."

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Analysts anticipate that Alphabet will earn free cash flow of $74 billion in 2023, up 24% from 2022, according to Trade Algo.

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Medical equipment firms hold worth in Stimpson's eyes as well. They are valued less highly than insurance or pharmaceutical healthcare firms and have the noncyclical growth characteristics that should shine in a potential global slowdown. He specifically names Stryker (SYK) and Zimmer Biomet Holdings ZBH -0.84% (ZBH).

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The American Century Stoxx U.S. Quality Growth exchange-traded fund (QGRO) seeks growth businesses with the highest profitability, earnings variability, and leverage scores. Booking Holdings (BKNG), Old Dominion Freight Line (ODFL), Cadence Design Systems (CDNS), Autodesk (ADSK), and Mastercard are among its top holdings (MA).

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Expect favorable yields from shorter-term bonds on the fixed-income side of the portfolio for some time. The 12-month U.S. Few people would have forecast the 5.1% yield on Treasury bills one year ago.

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