The US economy has defied expectations by staying strong despite higher interest rates. But BMO Capital Markets warns that weakness may be coming, since monetary policy works with a lag. Here are 24 high-quality stocks to buy now to protect your portfolio from higher rates. To the shock of the Federal Reserve and many on Wall Street, the US economy refuses to die.
Higher interest rates designed to slow inflation haven’t choked economic growth, crushed consumer spending, or sent the unemployment rate spiking like so many expected last summer.
Instead, inflation-adjusted GDP growth was robust for the second straight quarter, retail sales have stayed strong, and the labor market continues to add jobs.
Such strength is emboldening the US central bank to raise rates more than it originally planned. While investors are fearful that more rate hikes will put the three-year long economic expansion in jeopardy, recent economic data suggests that the economy could take a bit more tightening.
“The US economy has shown surprising resilience in weathering the blizzard of Fed rate hikes over the past year,” wrote Douglas Porter, the chief economist at BMO Capital Markets, in a quarterly research report published on March 9.
All eyes are on the Fed and inflationHowever, BMO doesn’t think that the US economy is out of the woods yet — so stocks aren’t either.
Monetary policy has a lagging effect, Porter noted, adding that households still have plenty of savings they’ve used to satisfy their pent-up demand for travel and other in-person activities.
But when the Fed’s rate hikes fully go into effect, excess savings will dry up, and pent-up demand will fade. Porter also warned of less hiring and more layoffs to the tune of an unemployment rate of 4.4% or higher. The economy will face other headwinds as well, including declines in real GDP, home prices, and fiscal stimulus.
“Despite a solid start to the year, we continue to look for a mild slump this year due to tighter financial conditions, as reflected in the sharply inverted yield curve and a lengthy decline in leading indicators,” Porter wrote.
Heading into 2023, BMO, JPMorgan, and a few other firms thought that a weaker economy and slowing inflation could encourage the Fed to cut interest rates in the second half of the year. Labor market resilience and the Fed’s latest messaging about the possibility of more rate hikes makes that dovish outcome “highly unlikely,” Porter wrote.
The US is at an inflection point, Porter noted. The Fed’s interest rate decision — and potentially the economy’s near-term future — hinges on how hot or cool inflation is in next Tuesday’s report.
“Stubborn inflation could require even more restrictive policy, leading to a much harder landing,” Porter wrote. “We attach roughly 15% odds on this scenario. However, there’s likely a greater chance (35% odds) of avoiding a downturn altogether if inflation falls more rapidly than expected, paving the way for an earlier policy reversal and easier financial conditions.”
24 quality stocks to buy nowInvestors who aren’t comfortable betting everything on a positive inflation report can insulate their portfolios from potential pain by buying high-quality stocks, according to BMO.
Quality stocks are starting to break out and take the reins from value-oriented companies, which the firm noted were among the biggest outperformers last year. That’s based on each style’s information ratio (IR), which is the main metric BMO uses to gauge risk vs reward for stocks.
“US quality has steadily climbed to the top of our quant rankings over the last quarter and is on the cusp of becoming the first factor group to outperform value in 2023,” wrote David Cheng, an ETF & quantitative analyst at BMO, in the same quarterly report.
BMO Capital Markets Below are 24 US stocks that currently have the best prospects for strong risk-adjusted returns, according to BMO. Along with each is its ticker, market capitalization, sector, and decile rank for its information ratio, with 1 meaning that it’s in the top 10% of companies.