Last year, things couldn’t have gone better for the stock market. The Federal Reserve intended to maintain its dovish monetary stance, and record-low interest rates were fueling hiring, acquisitions and innovation across the tech sector.
But oh, what a difference a year can make!
Last week, the US Bureau of Labor Statistics reported that the inflation rate for the past 12 months hit 8.3% in April, just a hair shy of its 40-year high. Although some aspects of inflation have been beyond the control of the Federal Reserve (for example, Russia invading Ukraine), hindsight has shown that the nation’s central bank left its foot on the gas for too long. Keeping interest rates near record lows for years, including buying long-term bonds through quantitative easing, appears to be a key reason why the Nasdaq Composite it has lost more than a quarter of its value and has firmly entered a bear market.
But if there’s a silver lining to stock market struggles, it’s that fear historically breeds opportunity for patient investors. All notable declines throughout history have finally been erased by a bull market rally.
What follows are three of the smartest stocks investors can buy in a Federal Reserve-induced bear market.
The first great buy in a Fed-fueled bear market is the nation’s largest power stock, NextEra Energy (SINGLE -0.76%).
First, utility stocks provide a basic need service. If you own or rent a home, chances are good that you need electricity to power your home appliances. Electricity demand doesn’t change much from year to year, leading to highly predictable cash flow for utilities. This cash flow transparency is what allows a company like NextEra to reserve capital for new infrastructure projects and acquisitions without negatively affecting its profitability or dividend.
What really sets NextEra apart from its competition (why it has such a large market cap relative to other utility providers) is its focus on renewable energy projects. No utility company is generating more capacity from wind or solar power than NextEra, and that’s unlikely to change anytime soon. The company has committed to spending up to $55 billion on infrastructure projects between 2020 and 2022. Additionally, Energy Resources, the renewable energy arm of NextEra Energy, expects its renewable energy and storage projects to total between 22,675 megawatts (MW) and 30,0000 MW between 2021 and 2024.
While renewable energy projects can be expensive, and NextEra’s management team is probably disappointed that lending rates are rising, these investments are well worth it. NextEra Energy not only gets ahead of potential changes to the Capitol’s green energy policy, but also significantly reduces its electricity generation costs. As a result, NextEra has grown steadily at a high single-digit percentage for over a decade. That compares with low single-digit growth for much of the utilities sector.
Considering NextEra has generated a positive total return, including dividends, for its shareholders in 19 of the last 20 years, it’s a smart buy in an unstable market.
Alliance Resource Partners
Another really smart stock to buy in a Fed-induced bear market is coal producer. Alliance Resource Partners (ARLP 4.34%).
Two years ago, the above sentence would have been a ridiculous statement. During the early stages of the pandemic, coal demand and price per tonne plummeted, exposing coal producers with leveraged balance sheets. Fortunately, Alliance Resource Partners was not among them. However, weak demand and uncertainty linked to COVID-19 forced the company to forego its dividend for a year.
But things have changed dramatically since the spring of 2020. The price per tonne of coal has risen 137% since the beginning of 2022, and has increased roughly eightfold since the 2020 low. unable to aggressively invest in infrastructure during the pandemic, supply chain constraints are expected to keep coal prices elevated for the foreseeable future.
What investors will appreciate about Alliance Resource Partners is the company’s ability to make volume and price commitments well in advance. According to the company’s first quarter report, more than 90% of its forecast of 35.5m tonnes to 37m tonnes is already locked in for 2022. In addition, 19.9m tonnes of production is committed and pegged at the price for 2023. This is a company that regularly commits production for three to four years to maintain transparent cash flow.
Alliance Resource Partners also has oil and natural gas royalties that should benefit the company for years to come. With crude oil and natural gas hitting multi-decade highs, the company can expect a big increase in adjusted royalty-based earnings before interest, taxes, depreciation and amortization (EBITDA).
If you need one more reason to trust Alliance Resource Partners, consider this: Your supercharged dividend is back! The company currently pays a yield of 7.4% and plans to increase its quarterly distribution by 10-15% per room for the remainder of 2022.
The third smart stock piling up during this Federal Reserve-driven bear market is a specialty biotech company. Vertex Pharmaceuticals (VRTX 1.23%).
The beauty of health stocks is that they are highly defensive. No matter how well or poorly the stock market performs, people can’t control when they get sick or what ailments they develop. This creates a baseline level of demand that drug manufacturers, medical device companies, and healthcare service providers can expect in any economic environment.
The differentiating factor that makes Vertex Pharmaceuticals special is its focus on treating patients with cystic fibrosis (CF). CF is a genetic disease with no cure characterized by the production of thick mucus, which can clog the lungs and/or pancreas of patients.
To date, Vertex has developed four generations of mutation-specific CF therapies that work to improve lung function, and is currently working on its next-generation treatment. The company’s most recently approved CF therapy, Trikafta, was given the green light five months before its scheduled Food and Drug Administration review date, and is on track to generate $7 billion in sales this year.
Beyond its treasure trove of CF, Vertex has more than a half-dozen compounds in development. While some of these therapies are being developed in-house, others, such as CTX001 for beta thalassemia and sickle cell disease, are partner projects. Given Vertex’s strong drug development track record, there’s a good chance that at least some of these treatments will make it to pharmacy shelves.
A final reason to be excited about Vertex is the company’s cash-rich balance sheet. With $8.24 billion in cash, cash equivalents and marketable securities (and no debt), the company has ample capital to continue its research and perhaps even make some purchases of its own.
With more than $15 a share in earnings forecast by Wall Street in 2023, Vertex has shown no signs of slowing down.