The markets are currently convinced that the Federal Reserve will begin cutting the Fed funds rate as soon as September. This news comes on the heels of April’s consumer price index reading showing that inflation, while at its lowest levels in two years at 4.9%, is 2.5-times above target levels.
That would suggest buying into the real estate, financials, and information technology sectors is a smart move.
Instead, I think that now is the time to be as defensive as ever. Indeed, 5% inflation is not an achievement. A recession remains on the horizon, and rates have been pushed so high and so quickly that banks have collapsed. The Fed has pushed its overnight rate to between 5-5.25% in May. The risk of something breaking is higher now.
With that said, let’s look at one sector to sell, and two to buy, for investors looking to navigate this choppy environment.
Sell: Financial Stocks
Investors should avoid buying financial stocks, even as the Fed tapers its rate hike campaign and signals a change in monetary policy. First of all, it’s clear that by increasing rates to between 5-5.25% in May, more risk has been introduced into the economy. Banking collapses happened in March and April when the Fed funds rate was between 4.5-5%. The Fed is simply pushing on with its campaign to reduce inflation unsuccessfully, while simultaneously increasing risk in the banking sector.
This most recent rate hike is necessary, yes, but also introduces risk. The Fed is effectively continuing to stress test the economy, but with little real idea of what the outcome will be.
That’s why it makes no sense to invest in financials currently. Banks are now as stressed as they’ve ever been. Big banks will get stronger. But outside of a select few, namely JPMorgan Chase (NYSE:JPM), I’d stay away.
And there’s no reason to believe we’ve avoided a recession, or that we will. A recession will flatten financial stocks, and it’s looking more likely by the day. Don’t celebrate 5% inflation. Take it as the sign of continued trouble that it is.
Buy: Healthcare Stocks
Healthcare stocks are an obvious investment to make at this time if you agree with my sentiment that things are no better now despite ‘softening’ inflation. The healthcare sector is a well-known defensive investment because it sees much less fluctuation in spending across the business cycle. People go to see the doctor no matter how bad the economy gets.
Last year again proved that reasoning to be true, as the healthcare sector fell 0.83% while the S&P 500 declined more than 16%.
Here’s another way to look at investing in the healthcare sector. Even if we somehow avoid a recession, inflation magically rectifies itself, and so on, healthcare will still grow. Other sectors perform relatively better in strong economic cycles, true. But your overall chances of winning are much better with the healthcare sector and stocks like United HeathGroup (NYSE:UNH).
Buy: Consumer Goods Stocks
The consumer goods sector has proven particularly resilient this year. Consumer packaged goods firms have continued to be bought and sold through 2023 as though there is no concern over inflation at all. Companies like Coca-Cola (NYSE:KO) and Pepsi (NYSE:PEP) have been able to pass on higher prices to willing consumers, leading to booming top- and bottom-line results.
Rather than having to eat higher costs and accept lower margins, these firms have been able to more than make up the difference, and yet consumers continue to indulge. It seems strange to me personally, as I’ve grown tired of paying $5 for a bag of chips, but I guess I clearly don’t represent the average consumer.
The consumer goods sector is very defensive in nature. As consumer demand shrinks, value propositions become more attractive. Thus, I expect undervalued consumer packaged goods stocks to become increasingly in vogue as we move into summer and Fall, when a recession is expected.
On the date of publication, Alex Sirois did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.