3 days Ago
tumsasedgars JPMorgan ( JPM ) CEO and billionaire Jamie Dimon recently cautioned that the worst-case scenario for the U.S. economy was not off the table and is, in fact, a very viable possibility.
While a recession would certainly be a bad outcome for the U.S. economy, an economic slowdown accompanied by inflation—commonly referred to as stagflation—would be even worse.
As Mr. Dimon stated: I would say the worst outcome is stagflation — recession, higher inflation. And by the way, I wouldn't take it off the table.
In this article, we will discuss why stagflation remains a very plausible scenario for the U.S. economy, as well as some of our top picks for navigating such an unpleasant outcome.
Why Stagflation Remains A Highly Plausible Scenario Stagflation is quite possible for several reasons. First of all, a weakening economy could likely result from a combination of economic weakness in some of our leading trade partners, like Japan, Europe, and China; deglobalization, which removes some of the productivity and efficiency of the global economy; ballooning consumer debt, which currently sits at record levels, thereby sapping consumer demand and purchasing power; and growing unemployment, which further weakens consumer purchasing power. On top of that, commercial real estate and middle-market businesses are also facing elevated debt costs that could lead to a spike in defaults on these loans.
This would ripple through the economy, with negative impacts on lenders like BDCs and regional banks, potentially leading to further chaos and destabilization for the economy. Meanwhile, inflation could quite possibly remain well above the Federal Reserve's target rate for the foreseeable future due to a combination of factors: deglobalization, which is leading to higher production costs, both in terms of labor, as well as the investment, needed to shift production to new locations; continued strains on the global energy supply due to ongoing wars and sanctions in the Middle East and Russia; and potentially continued restrictive regulations in the United States, especially should the Democrats win in November, which would impose regulations that make it harder and more expensive for businesses to operate, particularly in the energy production sector. Perhaps one of the biggest forces of all is artificial intelligence ("AI") investment.
While AI is expected to be overwhelmingly deflationary over the long term, over the next several years, the AI boom is actually expected to be inflationary as businesses and governments ramp up investments in the necessary infrastructure and energy production to facilitate large-scale AI applications. This will drive up costs, becoming an overwhelmingly inflationary force in the near term, which could be enough to prop up inflation even in an otherwise sagging economic environment. Additionally, a weakening economy may force the Fed to cut rates faster than it otherwise would.
While this could potentially soften the blow of an economic downturn, it could cause inflation to spike back up, especially if it leads to a sharp rise in commodity prices. This sort of scenario could be very bad news for many individuals and companies. Individuals would likely get hit by the double whammy of spiking unemployment and weakened wages due to a softer job market, while at the same time, they would continue to see the cost of living increase.
Meanwhile, companies would also struggle as weaker consumer spending and higher input costs, including the cost of capital from elevated interest rates, would hurt them meaningfully, leading to a vicious cycle. It would also be bad news for the U.S.
government, as a weaker economy could lead to lower tax revenues, while elevated interest rates from inflation could add further interest expense pressures to the budget deficit. This would likely force the U.S.
government at some point to make a hard choice between hiking taxes, thereby further aggravating economic hardships, or cutting back on government services and entitlement programs at a time when consumers would likely need the most help to deal with the weaker job market and higher inflation. Top Stagflationary Picks With this sobering outlook in view, here are three stocks that could be great options for weathering such an environment: Enterprise Products Partners ( EPD ) is well-positioned for a stagflationary environment. With long-dated contracts that have inflation-linked escalators, EPD should be able to hold up fairly well in an inflationary environment, especially since energy prices tend to do well during such periods.
Additionally, it has a very strong balance sheet with a sector-leading A- credit rating, a very low 3.0x leverage ratio, significant liquidity, and about an 18-year weighted average term to maturity on its debt. This positions it very well to weather an environment where interest rates may be higher for longer, and capital markets may be weaker due to an economic downturn.
Additionally, it is generating significant free cash flow that not only covers its distribution and fully funds its internal growth pipeline but also gives it the flexibility to potentially repurchase units opportunistically if the market gets weak and/or further support its balance sheet in the event of economic weakness. With a distribution yield of over 7% and a strong growth pipeline over the next few years, EPD appears likely to deliver solid returns regardless of macroeconomic conditions. Another opportunity that should perform well in a stagflationary environment relative to many other investments is W.
P. Carey ( WPC ). This is because its business model is very defensive against economic downturns due to its triple net leases, long-term lease maturities, and its BBB+ credit rating, which indicates a strong balance sheet with plenty of liquidity and long-dated maturities at an attractive cost of debt.
WPC also has a well-diversified portfolio that is increasingly weighted toward industrial real estate, which should help it weather an economic storm well. Meanwhile, it should also perform well in an inflationary environment because the majority of its rent comes from CPI-linked leases, while its debt maturities are well-staggered. In an environment where inflation remains elevated for an extended period, it should see organic growth receive a positive tailwind.
This sets it apart from many of its peers, such as Realty Income ( O ) and Agree Realty ( ADC ), which, while they have significant investment-grade tenant exposure, have little to no CPI-linked rent escalator exposure. Therefore, they will likely underperform in a stagflationary environment relative to WPC. Another attractive opportunity that should do well in a stagflationary environment is Brookfield Infrastructure Partners ( BIP )( BIPC ).
This is because its businesses are highly contracted and regulated, which gives it a very stable cash flow profile in the event of an economic downturn. Moreover, its balance sheet is strong, with a BBB+ credit rating and well-laddered debt maturities as well as the backing of A- rated Brookfield ( BN )( BAM ). The vast majority of its debt is non-recourse and at the asset level, meaning it should manage just fine during an economic downturn.
Meanwhile, the majority of its cash flows are indexed to inflation, and much of the rest is protected against inflation, which should provide it with solid organic growth even in a stagflationary environment. Additionally, like WPC, BIP has a distribution yield of a bit over 5%, and both of these businesses should generate solid growth for years to come, even in a stagflationary environment, making them highly likely to generate market-level or market-beating returns over the long term with below-average risk. Investor Takeaway While stagflation would be a bad scenario—or even potentially the worst-case scenario, as Jamie Dimon points out—for the U.
S. economy, with consumer purchasing power being hammered by weakening wages and higher unemployment combined with continued outsized price increases, investors could help shore up their portfolios against this scenario by investing in businesses that still have indexed exposure to inflation, like EPD, WPC, and BIP. Samuel Smith has a diverse background that includes being lead analyst and Vice President at several highly regarded dividend stock research firms.
He is a Professional Engineer and Project Management Professional and holds a B.S. in Civil Engineering & Mathematics from the United States Military Academy at West Point and has a Masters in Engineering with a focus on applied mathematics and machine learning.
Samuel leads the investing group High Yield Investor investing group. Samuel teams up with Jussi Askola and Paul R. Drake where they focus on finding the right balance between safety, growth, yield, and value.
High Yield Investor offers real-money core, retirement, and international portfolios. The service also features regular trade alerts, educational content, and an active chat room of like-minded investors. Learn more Analyst’s Disclosure: I/we have a beneficial long position in the shares of EPD, WPC, BIP either through stock ownership, options, or other derivatives.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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