“Until the job is done…”
Federal Reserve Chair Jerome Powell’s words are lingering in my mind this week.
Back in August, Powell vowed to raise interest rates to tame inflation “until the job was done.” And this week’s Consumer Price Index (CPI) numbers show that the job is nowhere close to the finish line. Inflation rose at an annualized rate of 8.3% in August.
Once again, the devil is in the details.
Excluding food and energy prices, which can swing from month to month and skew the picture, core inflation was up 0.6% compared to July and 6.3% year over year.
This all but guarantees the Fed will make its third consecutive 0.75% rate hike next week.
Just six months ago, the fed funds rate target range was 0% to 0.25%. By the end of this month, that will sit between 3% and 3.25%!
One increase in interest rates alone is bad. But with each monster hike, the risk grows that the Fed pushes us into recession (if we aren’t already there) … and creates that worst of all possible worlds — stagflation, where the economy slows in tandem with high unemployment and rising prices.
I don’t make major investment decisions based on data for a single month. That’s a terrible idea. I’ve never seen anyone make money trading the headlines like that.
But this does give us an opportunity to step back and look at the big picture and consider what kind of dividend strategy makes sense in a world of rates in rapid ascent.
3 Dividend Criteria as the Fed Fights Inflation
Today, let’s break down the criteria I like to see in a dividend stock that is both inflation-proof and recession-proof.
1. We Need Growth
Remember what a dividend is. It’s a distribution of profits to shareholders once all bills have been paid and some cash has been set aside for a rainy day.
In order to support and increase that dividend payout over the long haul, the company needs to be healthy and growing. Otherwise, it’s just a matter of time until the money gets tight and the company has to cut or eliminate the dividend.
You don’t want to be left holding the bag on a company in decline that can’t support its payout.
2. Beware of Cyclical Companies
No sector is off-limits to me as a trade. At the right price or under the right circumstances, any stock is fair game — at least as a short-term move.
But dividend plays are different. When looking for a stock you might hold for years or even decades, there are certain sectors you want to avoid.
As an example, consider automakers and airlines. When the economy is hot, both trend in the right direction. But both are prone to crashing during recessions. Those aren’t the kinds of companies you want to depend on as an income stocks.
If you depend on a dividend to pay for your current expenses, you can’t risk that the dividend gets lowered or eliminated at the first whiff of a recession.
For your income portfolio, stick with companies that are less sensitive to the economic cycle.
3. Look for Inflation Protection
Some companies are able to absorb inflation better than others.
For example: Service- and information-based businesses (e.g., software) have little in the way of materials costs.
Strong brands also weather inflation better in a lot of cases because their customers are willing to pay a premium. Coca-Cola, Pepsi, Procter & Gamble and Disney are all good examples here.
Customers stick with brands they know and love and are willing to pay up for them. In return, these companies can pass their own increased costs onto their loyal customers.
Many real estate investment trusts (REITs) also have built-in inflation protection in the form of rent escalations that are calculated based on inflation and other price factors such as demand.
Bottom line: It’s impossible to escape the effects of inflation and the Fed’s attempts to stamp it out. But limiting your dividend stock portfolio to the right kinds of companies puts you in a much better position to ride out whatever comes next. Before you know it, you’re on the other side with a higher income stream.
And speaking of that…
You’ll want to catch the next issue of Green Zone Fortunes, where I recommend one of my favorite high-yield income stocks. It has a multidecade history of raising its payout in every market condition under the sun.
To safe profits,
Charles Sizemore, Co-Editor, Green Zone Fortunes
Charles Sizemore is the co-editor of Green Zone Fortunes and specializes in income and retirement topics. He is also a frequent guest on CNBC, Bloomberg and Fox Business.