• Tue. Nov 22nd, 2022

3 of the smartest stocks to buy in a Fed-induced bear market

ByMadeleine J. Pierce

Nov 17, 2022

Every once in a while, the stock market sends a stern reminder to the investing community that stock valuations don’t climb in a straight line — even if 2021 led you to believe they did. It’s been one of those years. Since hitting their respective all-time highs between November 2021 and the first week of January, Dow Jones Industrial Average, S&P500and Nasdaq Compound all entered a bear marketwith maximum drops ranging from 22% to 38%.

While there are many factors that have pushed Wall Street into a bear market, the bulk of the accusations are rightly aimed at the Federal Reserve. In retrospect, the Fed’s accommodative monetary policy, including its decision to maintain quantitative easing measures (i.e. the purchase of long-term bonds aimed at keeping lending rates low), has been a key factor in the runaway rate of inflation recorded this year. With the country’s central bank aggressively raising interest rates to control inflationit removed the cheap capital that had fueled growth stocks for so long.

Image source: Getty Images.

But there is one upside to a Fed-induced bear market: bargains. Long-term investors have the opportunity to acquire high-quality companies at a discount, thanks to central bank errors. Here are three of the smartest stocks to buy in a Fed-induced bear market.

Bank of America

The first genius buy in a Fed-induced bear market is none other than a banking giant Bank of America (BAC -0.90%).

Firstly, banking stocks are cyclical and therefore exposed to temporary weakness in the economy that may be caused by the Fed raising its target federal funds rate by a total of 375 basis points in less than a year. It is not uncommon for banks to face higher loan losses during recessions.

On the other hand, this is not a typical Fed tightening cycle. This is the first time in history that the Fed has had no choice but to aggressively raise interest rates in a plummeting market. This means that some dynamics are changing for banking stocks – in this case for the better.

Although Bank of America is likely to see delinquencies and/or charges increase in coming quarters, rising interest rates are helping the company generate more net interest income on its interest rate loans. current variable. In reality, no monetary central bank is more sensitive to interest rate fluctuations than BofA. With the Fed aggressively raising rates, BofA recognized a $2.7 billion year-over-year jump in net interest income to $13.9 billion in the quarter ended September.

To add to the above, Bank of America estimates that a parallel shift of 100 basis points in the yield curve would produce $4.2 billion in additional net interest income over the next 12 months. The Fed has already moved another 75 basis points after the release of BofA’s third quarter results.

Bank of America digitization initiatives bear fruit, too. Digital transactions, such as banking online or through a mobile app, are considerably cheaper for banks than face-to-face interactions. BofA increased the number of active digital users from 5 million to 43 million over the three-year period. More importantly, 48% of total sales were made digitally in the third quarter, an increase of 19 percentage points compared to the comparable period of 2019.

In short, the benefits of higher interest rates and this digital shift far outweigh concerns about short-term loan losses. This makes BofA an absolute steal to 10 times earnings for the coming year.

Palo Alto Networks

The second extremely smart stock to buy in a Fed-induced bear market is cyber security stock Palo Alto Networks (PANW -2.03%).

If there’s a knock against Palo Alto Networks, it’s the company’s valuation (43 times earnings for the coming year). During bear markets, it’s not uncommon to see companies with premium valuations take a beating. But the valuation is a poor reason to avoid what appears to be a fast-growing and highly profitable player in cybersecurity.

One of the best things about cybersecurity as a whole is that it’s a very defensive industry. No matter how the US economy performs, bots and hackers will always be out there trying to steal sensitive data. This makes data protection increasingly important, especially with companies that regularly move their operations and data online and into the cloud.

What has helped Palo Alto Networks turn heads is the company’s four years business transformation. During this period, the company reduced the importance of physical firewall products in favor of SaaS (software as a service) subscriptions. SaaS solutions are more agile in responding to and addressing potential threats, and generate more predictable cash flow and better gross margin than physical firewall products.

Perhaps most interesting is the effect this change has had on the wooing of large companies. In the past two years alone, the number of customers spending $1 million over 12 months has increased 65% to 1,240 at the end of fiscal year 2022 (Palo Alto’s fiscal year ends July 31) . This ability to attract larger customers has actually accelerated its sales growth at a time when most other companies see weaker growth prospects.

Another thing to consider about Palo Alto Networks is the company long history of targeted acquisitions. Although higher interest rates may deter some future acquisitions, the company has consistently relied on smaller purchases to expand its product/service ecosystem and sell its solutions.

A bear market caused primarily by the Fed will not have a substantial impact on Palo Alto’s torrid growth trajectory.

An engineer using a walkie-talkie while standing next to energy pipeline infrastructure.

Image source: Getty Images.

Enterprise Product Partners

The third smart stock to buy in a Fed-induced bear market is energy store Enterprise Product Partners (EPD 0.48%).

For some, the idea of ​​putting your money to work in an oil and gas stock may not be appealing. It was, after all, just 31 months ago when West Texas Intermediate crude oil futures briefly traded at minus $40 a barrel. The volatility inherent in energy stocks since the start of the pandemic has made this industry an adventure, to say the least.

However, enterprise product partners can easily ease investor fears, even in an environment of rapidly rising interest rates. This is because it is a midstream oil and gas company. As Drillers Fluctuate With Energy Commodity Spot Prices, Intermediate Operators Sign long-term fixed-price or volume contracts with drillers upstream to transport, store and possibly process energy products. These contracts are specifically designed to remove the effects of inflation and spot price volatility from the equation.

Being able to accurately predict the operating cash flow it will generate in any given year, regardless of the size of the oil and natural gas market, is very important for Enterprise Product Partners. Having a solid understanding of its cash flow is what has enabled the company to invest $5.5 billion (in total) in more than a dozen infrastructure projects. Most of these projects, which are heavily oriented towards natural gas liquids, are expected to be operational by the end of 2023.

Enterprise Products Partners also appears to be in a ideal position to profit from the woes of the global energy supply chain. Earlier this year, Russia invaded Ukraine, casting doubt on Europe’s supply of energy raw materials in the near term. Likewise, global energy companies have reduced their investments during the pandemic. The end result of all of this is an inability to rapidly increase oil and gas production anytime soon. That would seem like a recipe for higher oil and gas prices, and all the more reason for drillers to possibly increase production. More production equals more long-term interim contracts for Enterprise.

And don’t overlook this company’s exceptional dividend. Enterprise Products Partners has increased its base annual distribution in each of the past 24 years and is currently distributing an anti-inflationary return of 7.6%. At no time during the worst of the pandemic has this payment threatened to be reduced.

Valued at less than 10 times Wall Street’s projected earnings for 2023, Enterprise Products Partners appears to be brimming with potential.