As Inflation Uncertainty Rises, Defend Yourself with These High-Quality Stocks

Editor’s Note: The TradeSmith offices will be closed Monday, Jan. 20 for MLK Day – as will the markets. We’ll be back on Tuesday, Jan. 21.

We’re two trading weeks into the new year, and stocks remain under selling pressure – as Treasury bond yields steadily surge higher, and inflation concerns cast a dark cloud going into 2025’s first earnings season.

The main culprit – of both the higher yields and the market’s current fears – is uncertainty: Wall Street is wondering if inflation is well and truly licked, or if consumer and producer prices are on track to reflate higher once again.

And while Wall Street wonders, bond traders already seem convinced that inflation could be a problem as we enter February. That’s why yields on the 10-year Treasury are dangerously close to breaking out above 5% as Treasury bonds tumble in price.

The combination of chronic government deficits, which could get deeper with proposed tax cuts, along with soon-to-be President Trump’s promised trade tariffs, are all pointing to the high possibility of higher inflation down the line – despite the Federal Reserve’s recent efforts to bring inflation down from its post-pandemic highs.

If this all seems familiar, you aren’t wrong: we’ve been down this road before.

In the early 1970s, the Federal Reserve believed inflation was handled and resolved, as you can see in the chart above. Then, when the economy faltered, they blinked. The Fed cut rates prematurely… and inflation surged higher again.

This wasn’t an isolated incident either.

Historically, there have been several times where inflation has jumped above 5%, temporarily declined, then accelerated higher in a second – or even a third wave – that lasted for years, as you can see below:

And what’s driving today’s inflation isn’t just a fear of future deficits or tariffs.

Services and shelter inflation are both key components of the Consumer Price Index (CPI). That’s no surprise: service sector spending accounts for about 75% or our total economy, so it has a big impact on inflation.

And as you can see above, recent readings from the ISM Services Prices Paid Index jumped to 64.4 last month – the highest reading in almost two years. This tells us that service costs are on the rise for American businesses.

That’s the big reason why Treasury yields are on the rise too. And bond traders have taken notice.

The Treasury five-year inflation breakeven spread is a market-based expectation of future inflation. And as you can see, it’s also been on the rise recently – breaking out above a clear downtrend:

This tells me that investors in the $26-trillion Treasury bond market are already seeking shelter from higher inflation. And with higher yields and renewed inflation fears, it’s no surprise that stocks have been under continued pressure.

Future appreciation potential for individual stocks – and the entire stock market – are all tied to earnings, which are discounted by the prevailing interest rate.

When that discount rate goes up, as it has the past few months, stocks are theoretically worth less. Hence the recent stock market pullback.

So, with inflation an uncertain wildcard for investors, I suggest returning to an old favorite strategy of mine – a strategy that I’ve detailed before.

Simply, consider searching for inflation-resistant stocks.

With that in mind, I’ve put together a simple TradeSmith screener that scans our database for high-quality stocks that have noteworthy pricing power.

Typically, these are stocks with durable competitive advantages – on companies that also possess both resilient sales and profit growth. That means these firms can more easily raise prices when inflation rises, to preserve their profit margins and maintain quality earnings.

Here’s a screenshot of my inflation-resistant stock screener. You can use these settings to add this screener to your own list of screens as-is, or adjust the settings further to make it your own:

As you can see, I’m looking for healthy stocks (in the Health Indicator Green and Yellow Zones) that are in an Up Trend – starting with those with average or lower volatility, as measured by our TradeSmith Volatility Quotient (VQ%).

Next, I want to zero in on stocks with a Business Quality Score (BQS) of 80 or higher. That’s the cream of the crop, the top 20% of stocks we rank for quality.

Finally, I insist on only reviewing stocks with strong Free Cash Flow yields of 5% or more. Strong Free Cash Flow generation makes for stocks with real pricing power – which means our results will be shielded from inflation to a greater degree.

When I ran this screen earlier this week, I found 52 stocks that made the cut. Here’s a screenshot of the top 20 stocks that made the grade, sorted by Free Cash Flow yields:

Mike Burnick’s Bottom Line: If inflation does rear its ugly head again this year, be sure to seek out quality stocks with significant pricing power.

These high-quality companies with strong Free Cash Flow yields aren’t just primed to survive inflation – but to thrive during it. And if prices continue to sink, these high-quality names offer a strong defense for your portfolio.

Good investing,

Mike Burnick
Senior Analyst, TradeSmith

P.S. With inflation fears putting pressure on the market, it’s a good time to position your portfolio defensively with high-quality stocks.

But shoring up your defenses doesn’t mean you should just sit and wait for the markets to settle. There are still plenty of chances to profit in this rocky January… and there’s one window of opportunity opening next week you won’t want to miss.

Jeff Clark – TradeSmith’s newest corporate partner – is a long-time veteran of the stock market. He’s led trading firms, served some of California’s wealthiest individuals, and developed the curriculum for an international MBA program… and he believes that next week, Trump’s presidential inauguration will begin a historic period of massive market volatility: a period that could deliver life-changing profits to those equipped to trade through the chaos.

Next Wednesday, Jan. 22, Jeff is hosting a webinar event to clue you in on his strategy to make the most of Trump’s return to the White House. He’ll share his top trade for the first week of Trump’s second term – and show you why he sees the potential to double your money each week over Trump’s honeymoon phase.

Click HERE to secure your spot at Jeff’s Most Profitable 100 Days of Your Life Event. You won’t want to miss it – not with Inauguration Day just around the corner.