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4 Stocks to Avoid If Inflation Heats Up

Monday, something rare and unsettling happened in the markets. Equities, bonds and the dollar index were all down, while at the same time commodities were up. This is very rare because when stocks are down, investors typically seek safe havens in either U.S. treasuries or the dollar or both, which tend to rise to compensate. If both stocks and bonds are down together, which is uncommon but not exactly rare, then the dollar usually rises as the safe haven that day.

If all three are down together on any day — stocks bonds and the dollar in a trifecta — which would qualify as rare but not exceedingly so, then commodities are often down as well in an across the board down day. But to have everything down but commodities is extremely rare and an ominous sign. If it continues for any length of time, it is a sign of stagflation. During stagflation, commodity prices rise, but not because of rising demand from a growing economy. Rather they rise because of a falling dollar, or inflation.

Back in 1958 when stagflation hit the U.S. economy for the first time, then Federal Reserve Chairman Arthur Burns was questioned by his doctoral student Murray Rothbard as to what he would do as Fed chairman if stagflation were to ever hit the U.S. economy again.

“Then,” said Burns, “we would all have to resign.”

ALSO READ: Deutsche Bank Says Stick With Top Stocks Growing Dividends

Stagflation was to hit the U.S. economy again in 1970 and last for the better part of the decade, until Paul Volcker pushed interest rates to absolute extremes by 1980, restoring confidence in the dollar. Some define stagflation as double-digit inflation plus recession, which occurred twice in the 1970s, though single-digit inflation plus economic stagnation was almost constant throughout most of the decade.

Stagflation happens when money printing slows down while, at the same time, money that was already printed and loaned out to fuel the previous boom floods into the consumer sector. The result is rising consumer prices with a recession.

One day of this type of trading pattern is definitely not enough to confirm a trend, but if what happened Monday keeps happening, here are four stocks to avoid, or sell if you own them.

Buffalo Wild Wings

Buffalo Wild Wings Inc. (NASDAQ: BWLD) is a healthy company that has not been hit that badly by the latest correction. That is because restaurant stocks usually do fine in average corrections that are not inflationary, but not so much if inflation is added to the mix. The top-to-bottom profit margins of restaurants are very small because they are at the very tip of the consumer sector, even more so than supermarkets because consumption takes place on site. Buffalo Wild Wings is on the high end of the profit margin range at between 5% and 6% with growing revenues, which is why its stock is flying high. But any significant rise in inflation quickly will eat into these margins as cost of revenue rises.

ALSO READ: 7 Analyst Stocks Under $10 With Massive Upside

Costco

Costco Wholesale Corp. (NASDAQ: COST) may seem like a good recession stock, but its margins are so razor thin at 1.8% that any rise in the cost of its products could have a very damaging snowball effect, all the way down to its bottom line. Costco’s business revolves around pricing its goods as low as possible while remaining barely profitable in order to attract members to its wholesale stores. If low prices cannot be maintained due to high inflation, Costco will be in big trouble. If you are after recession-proof retailers, stick to ones with higher profit margins.

Tiffany

When prices start to rise, unnecessary luxury spending is one of the first things to go. Tiffany & Co. (NYSE: TIF) is an unpredictable jeweler whose profit margins gyrate wildly from year to year, showing that it is already susceptible to bad management. With precious metals prices at multiyear lows, this should be the time when Tiffany shines, but it isn’t. If conditions worsen for the jewelry industry, which inflation would easily cause, Tiffany could fall far.

Western Asset Mortgage Capital

Mortgage real estate investment trusts, or REITS, invest in mortgage-backed securities and distribute income to shareholders. Western Asset Mortgage Capital Corp. (NYSE: WMC), for example, has a 21% dividend yield. This certainly sounds attractive, but the entire model is dependent on very low interest rates, which pushes the value of its mortgage-backed securities higher because it keeps people from defaulting on them. The fact that these REITS have been tanking in value as an asset class already is also quite ominous. If inflation does pick up, especially stagflation, the value of the mortgage-backed securities these REITS hold will plummet as the Fed will be forced to raise interest rates significantly, much like Volcker was forced to do in the late 1970s. High-dividend mortgage REITs are not the place to be right now.

ALSO READ: 5 Stocks Buffett Likely Bought During the Sell-Off

By Rafi Farber


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