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5 Quality Picks as Fed Hikes Rate, Turns Hawkish for 2019

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As expected, the Federal Reserve, headed by the new chairman Jerome Powell, raised interest rates for the sixth time since the financial crisis by 0.25% to 1.50-1.75%. The central bank hinted at gradual hikes for this year with two lift-offs but turned hawkish for 2019 and 2020, citing growing confidence in the strengthening economy.

The Fed is cautious about rising trade tensions. Trump has recently announced tariffs on steel and aluminum imports and is seeking to slap a series of tariffs on China imports, targeting the technology, telecommunications and apparel sectors that could hit $60 billion goods in the world's second-largest economy. The action could lead to threats of retaliation or even a trade war.

However, Powell signaled for faster rate hikes for the next few years as the massive $1.5 trillion tax cut and a bipartisan $300-billion spending plan could overheat the robust labor market, flaring up inflation and calling for aggressive policy tightening. The Fed now sees a total of eight quarter-point hikes in the fed-funds rate through the end of 2020 to near 3.4%. This includes three increases this year, including the latest move, three in 2019, and two in 2020.

The Fed raised the economic growth forecast to 2.7% this year from 2.5% and 2.4% for 2019 from 2.1%. Inflation is expected to stay at 1.9% this year and return to the Fed’s target of 2% in the next. Additionally, unemployment rate, which is at 17-year low of 4.1%, is expected to fall further to 3.8% at the end of this year and 3.6% at the end of the next.

Higher Rates: A Reason to Worry

Higher rates would attract more capital to the country, thereby boosting the U.S. dollar against the basket of other currencies. This would leave a huge impact on commodity-linked investments, reflecting that a rising rate environment will hurt a number of segments. In particular, high dividend paying sectors such as utilities and real estate would be the worst hit given their higher sensitivity to rising interest rates.

Additionally, securities in capital-intensive sectors like telecom would also be hit by higher rates. Higher rates would result in tighter lending conditions and curtail consumer spending on a wide range of products like cars and houses. This will in turn dent profitability across various segments. Further, businesses will also face higher loan rates over time.

All these combinations would lead to heightened market volatility and threaten the nine-year bull market. Against such a backdrop, quality stocks tends to outperform as these are rich in value characteristics with healthy balance sheets, high return on capital, low volatility, elevated margins, and a track of stable or rising sales and earnings growth. Quality investing also seeks safety and protection against volatility in turbulent times.

Given this, we have highlighted five solid picks targeting this niche strategy for investors seeking to capitalize higher rates and a volatile market.

How to Select Quality Stocks?

To find out the best stocks in this space, we have used the Zacks Stock Screener. The parameters include Zacks Rank #1 (Strong Buy) or 2 (Buy), VGM Score of B or better, ROE of at least 10%, debt-to-equity ratio of less than 1, positive 5-year historic EPS growth, positive current-year EPS growth, positive current-year earnings estimate revisions over the past 30 days, and dividend yield of greater than 1%.

Universal Forest Products Inc. (UFPI - Free Report)

The Michigan-based company designs, manufactures, and markets wood and wood-alternative products in North America, Europe, Asia and Australia.

Zacks Stock Rank: #2
VGM Score: B
ROE: 12.10%
Debt/Equity: 0.15
5 Year Historical EPS Growth: 36.98%
Fiscal Year Earnings Growth: 27.72%
Positive Earnings Estimate Revisions Over 30 Days: 7.31%
Dividend Yield: 1.02%

Louisiana-Pacific Corporation (LPX - Free Report)

This Tennessee-based company manufactures building materials and engineered wood products in the United States, Canada, Chile and Brazil. You can see the complete list of today’s Zacks #1 Rank stocks here.

Zacks Stock Rank: #1
VGM Score: B
ROE: 24.05%
Debt/Equity: 0.22
5 Year Historical EPS Growth: 10.34%
Fiscal Year Earnings Growth: 12.53%
Positive Earnings Estimate Revisions Over 30 Days: 1.14%
Dividend Yield: 1.79%

Crane Co. (CR - Free Report)

This Connecticut-based company is a diversified manufacturer of highly engineered industrial products. It provides products and solutions to customers in the aerospace, electronics, hydrocarbon processing, petrochemical, chemical, power generation, automated merchandising, transportation and other markets.

Zacks Stock Rank: #2
VGM Score: A
ROE: 20.66%
Debt/Equity: 0.37
5 Year Historical EPS Growth: 1.63%
Fiscal Year Earnings Growth: 21.85%
Positive Earnings Estimate Revisions Over 30 Days: 2.39%
Dividend Yield: 1.46%

Dollar General Corporation (DG - Free Report)

This Tennessee-based discount retailer provides various merchandise products in South, Southwest, Midwest, and Eastern United States.

Zacks Stock Rank: #2
VGM Score: A
ROE: 21.65%
Debt/Equity: 0.43
5 Year Historical EPS Growth: 10.61%
Fiscal Year Earnings Growth: 33.63%
Positive Earnings Estimate Revisions Over 30 Days: 7.36%
Dividend Yield: 1.12%

Huntsman Corporation (HUN - Free Report)

This Texas-based company is among the world's largest global manufacturers of differentiated and commodity chemical products for a variety of industrial and consumer applications.

Zacks Stock Rank: #2
VGM Score: A
ROE: 29.3%
Debt/Equity: 0.67
5 Year Historical EPS Growth: 6.78%
Fiscal Year Earnings Growth: 10.48%
Positive Earnings Estimate Revisions Over 30 Days: 3.79%
Dividend Yield: 2.10%

Bottom Line

Quality stocks are not only better picks in a rising rate environment but often provide hedge against market volatility, which has intensified due to the possible trade war fears. Adding any of the above-mentioned stocks to one’s long-term portfolio could be worthwhile thanks to their credit worthiness and soundness. Further, the current market dip is a great time to buy high-quality names at an attractive price.

Zacks Editor-in-Chief Goes "All In" on This Stock

Full disclosure, Kevin Matras now has more of his own money in one particular stock than in any other. He believes in its short-term profit potential and also in its prospects to more than double by 2019. Today he reveals and explains his surprising move in a new Special Report.

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