Inflation Worries To Stall Rate Hikes? 4 Great Picks

When the Fed voted to raise rates last week, Minneapolis Fed President Neel Kashkari emerged as the lone voice of dissent. The Fed Chair and her colleagues had cited rising inflation as a reason for their decision. But Kashkari finds no evidence to that effect in his note. Instead, he wonders how the U.S. could be grappling with rising prices even as the rest of the world has experienced depressed prices since the global financial crisis.

Inflation data released over the past three months seem to bear out the Minneapolis Fed President’s views on price rise. Meanwhile, some of his colleagues at the central bank have also chimed in to record their concerns about inflation and the Fed’s likely rate hike schedule.

Some have even gone on to suggest that the Fed might not hike rates further, or at best, wait for further evidence on inflation to do. Treasury yields declined on Tuesday, heightening concerns over the issue even further. It seems investing in stocks benefiting from a soft interest rate environment may be a prudent option even at this point.

Fed’s Inflation Target Remains Evasive

In May, the Fed’s preferred inflation gauge, core PCE inflation, increased by only 1.5%. This was the poorest level recorded since Dec 2005 and far off the Fed’s target rate of 2%. Fed Reserve Governor Lael Brainard commented that the PCE measure had remained below the central bank’s target rate despite the fact that unemployment had fallen drastically.

Another Fed policymaker, James Bullard, had gone on to say that the Philips curve had failed to work in the case of the U.S. The theory underlying the curve postulates that inflation and unemployment are inversely related.

Can the Philips Curve Be Trusted?

Kashkari had raised the same issue in his note of dissent, saying that excessive faith regarding the validity of the theory was driving the Fed to make imprudent decisions. He added that the present FOMC was so focused on controlling inflation, given its belief in the Philips curve, that it was discounting the role of expectations. In effect, the central bank was repeating its mistakes of the seventies.

If at all the relationship between inflation and unemployment remains intact, it implies that the Philips curve has flattened. Further evidence was available last week, when core CPI Inflation, which excludes volatile food and fuel costs, increased only 1.7% on a yearly basis in May. This is the lowest increase recorded since May 2015 when it hit 1.9%. And yet the unemployment rate declined from 4.4% to 4.3% in May, marking its lowest level since 2001.

Officials Favor Gradual Approach on Rate Hikes

Already, a debate of sorts is brewing among Fed policymakers on the future path of rate hikes. With the Fed slated to raise rates at least once more this year, voices of dissent are growing louder. Late on Monday, Chicago Fed President Charles Evans hinted that the Fed may not go on to raise rates again this year. Expressing concern about prevailing levels of inflation, Evans said that the Fed should raise rates and trim its balance sheet gradually.

Dallas Fed President Robert Kaplan has expressed similar concerns. Speaking in California, Kaplan said that he was looking for further evidence to show that the decline in inflation levels was only a transitory phenomenon. Eric Rosengren expressed similar views in Amsterdam on Tuesday, saying that lower rates may become a fixture across economies since they were in line with population trends.

Our Choices

Though the Fed has stated that another rate hike is more than likely this year, voices emerging from the central bank indicate otherwise. Concerns about inflation and a sluggish economy means that the path of rate hikes now seems unclear. Falling Treasury yields provide further evidence to that effect.

This is why investing in stocks from the utilities, telecom, real estate and consumer discretionary sectors looks prudent at this time. All of these are likely to gain in a sustained low-rate environment. However, picking winning stocks may be difficult.

This is where our VGM score comes in. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners. However, it is important to keep in mind that each Style Score will carry a different weight while arriving at a VGM score.

We have narrowed down our search to the following stocks based on a good Zacks Rank and VGM score.

H&R Block, Inc. (NYSE:HRB) is a leading provider of tax preparation services. Through its subsidiaries, the company provides tax, accounting and business consulting services and products.

H&R Block has a Zacks Rank #1 (Strong Buy) and a VGM Score of A. The company has expected earnings growth of 15.2% for the current year. Its earnings estimate for the current year has improved by 10.2% over the last 30 days. The stock has returned 29% over the last three months, outperforming the Zacks Consumer Services - Miscellaneous Market sector, which has gained 22.9% over the same period.

Telephone & Data Systems Inc. (NYSE:TDS) is a diversified telecom service provider offering wireless and wireline services in 36 states.

Telephone & Data Systems has a VGM Score of A. The stock has returned 9.7% over the last three months, outperforming the Zacks Wireline - National Market sector, which has gained 9.4% over the same period. The stock has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

M.D.C. Holdings, Inc. (NYSE:MDC) is engaged in the construction, sale and related financing of residential housing.

M.D.C. Holdings has a Zacks Rank #2 (Buy) and a VGM Score of B. The company has expected earnings growth of 27.1% for the current year. Its earnings estimate for the current year has improved by 0.4% over the last 60 days. The stock has returned 19.8% over the last three months, outperforming the Zacks Building Products - Home Builders Market sector, which has gained 7.8% over the same period.

Avista Corporation (NYSE:AVA) is a diversified energy company with utility and subsidiary operations located throughout North America.

Avista has a Zacks Rank #2 and a VGM Score of B. Its earnings estimate for the current year has improved by 1.6% over the last 60 days. The stock has returned 11.2% over the last three months, outperforming the Zacks Utility - Electric Power Market sector, which has gained 1.6% over the same period.

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