Inflation and the stock market

To keep price rises stable, the government sets the Bank of England an inflation target of 2% a year. This stability helps businesses and consumers plan for the future. Stock markets tend to like this level of predicability when it comes to the economy and company earnings.

If inflation does jump 10 times higher than this 2% target, then clearly the UK economy is in for a rough ride. Consumers will likely cut back on spending, which would hurt the earning potential of companies. The stock market will likely fall to reflect this decline. It could even crash.

So, what should I do (if anything) to prepare my portfolio for this possibility?

The long game

One of the most important lessons I’ve learned as an investor is to always remember the game I’m playing. There are many strategies and games being played each day in the stock market. There are day traders, speculators, hedge funds, and robot traders that buy and sell thousands of stocks per second.

I like to use a football analogy when thinking about this. Imagine there’s one giant pitch (the stock market), and there are thousands of different games of football being played on it at the same time. Professional, amateur, five-a-side, futsal, penalties, and so on. Every player is trying to win (make returns) within their own game.

However, most of these players are not playing my game, which is long-term investing. I have a different time frame to these other investors, yet we’re all on this same pitch that is the stock market. So I need to know which game I’m playing, and stick to it.

Success is where preparation and opportunity meet

To me, being long term as an investor means not being scared into selling my positions when economic downturns affect the market. I try to remind myself of this as much as possible, especially when markets tumble. It really helps me stay focused on my long-term plan of slowly building wealth over time.

Obviously it wouldn’t be nice to see the value of my portfolio fall if the market crashes. But I’ve built some cash reserves up so I’m not forced into selling my shares at lower prices.

I’ve also made a list of great companies I’d like to own if their shares went on sale during a crash. These include British drinks giant Diageo and Watsco, the leading HVAC distributor in America.

Ultimately, nobody knows for certain when a stock market crash will happen. If it’s this winter, then I’ll use it as a buying opportunity to add more shares to my portfolio.  

As such, I own a handful of US equities in my portfolio. These are my three favourite US stocks to buy today. 

Stocks to buy for growth

The first company on my list, which I already own and would be happy to buy more of, is Visa (NYSE: V).

The corporation operates one of the world’s main payment networks. It connects buyers and sellers who are using Visa-branded networks and cards. With the number of cashless transactions rising worldwide, the company is one of the primary beneficiaries. 

What’s more, as one of the world’s largest payment network operators, Visa’s size is a substantial competitive advantage. It would cost a competitor tens of billions of dollars and many years to take over the firm’s position in the market. 

These are the two main reasons I would buy the stock for my portfolio today. However, the firm can’t take its position in the market for granted. Competitors are nipping at its heels. The company needs to stay alert to fend off the competition, or it could fall behind. 

Growing market 

Sticking with companies that have robust competitive advantages, I would also acquire Nvidia (NASDAQ: NVDA). 

The organisation is one of the world’s most prominent designers and producers of high-performance computer processors. The demand for these is exploding as the market for digital services also explodes. 

Nivida is reaping the benefits of this market expansion. The company’s net income lept 84% year-on-year in the third quarter. The organisation reinvests virtually all of its income back into processor development.

This spending only helps reinforce the group’s leading position in the market. As long as the firm continues with this strategy, I reckon its growth should also continue. 

Challenges it could face going forward include the supply chain crisis and rising input costs, which may increase the costs for consumers. 

Market maker 

I also think Goldman Sachs (NYSE: GS) is one of the best stocks to buy in the US today. I would acquire the shares because the company has an unrivalled franchise in the US equity markets.

The investment bank is one of the most recognisable brands on Wall Street. It manages the wealth of the rich and famous through its wealth management arm. This brings in a steady stream of recurring income. 

At the same time, the group has a leading position in the market for taking companies public. Over the past two years, this division has been a healthy profit centre for the organisation. 

Thanks to its position in these two markets, I think Goldman has a definite competitive advantage, although this is a competitive business. Keeping customers happy is one of the main challenges the business faces, or they could move to rivals.

No points for guessing the reason for the stock market rally though. The US’s election polls had global stock markets on tenterhooks for much of last week and the rally was initially driven by Biden’s win. Pfizer’s successful coronavirus vaccine has also added to huge investor relief.

What the ‘Biden bounce’ means for the FTSE 100

Both imply that the worst is over for stock markets. Uncertainty around the US’s political future was moving them sideways and Covid-19, of course, had sent businesses across the world in the doldrums. The US economy was expected to show healthy growth in 2021, but forecasters like Goldman Sachs said that a Biden win would improve growth prospects even more.

I think companies with a strong US market stand to gain. Recently, I wrote about how the Irish construction firm CRH could be a big gainer in time. There are at least two more stocks in this category. One is Ashtead, the FTSE 100 industrial equipment rental company. More than half its revenues come from the US.

Another is the FTSE 100 luxury brand, Burberry. It will get a double boost in demand from a Chinese bounceback and now the US. The US accounts for a smaller, but still substantial 23%, share in its revenues.

FTSE 250 stocks to consider

In a similar vein, I’d now consider buying the beleaguered fashion brand and retailer Ted Baker. After a reset following last year’s fiasco, the company has been struggling like many others in 2020. However, with 30% of its sales generated in North America, the tide may be about to turn for it.

I’m also hopeful about Cineworld, which has a strong US presence too. Its share price has already bounced back, with a very likely shot in the arm from the Pfizer news.  

FTSE 100 stocks I’d avoid now

FTSE 100 precious metals giant Polymetal International, on the other hand, has weaker prospects in my view than earlier. The reasoning is straightforward. Precious metal stocks have rallied this year on macro-economic and financial markets uncertainty. With some stability back, I reckon the gold price’s rise will slow down. This, in turn, will impact gold stocks. 

It doesn’t mean that all will be lost for them. POLY, for instance, showed strong revenue growth even before the gold price rally. But if the price of gold is the sole reason for buying the stock, I’d think it through first.

I’d think similarly about Fresnillo, another FTSE 100 precious metals miner. It may not have lost its lustre, but it is probably dimmed for now. If Pfizer’s vaccine news turns out less positive than is now suggested, there could be a bounce-back in gold stocks. Over time though, I reckon their growth will temper.

Royal Mail share price

Source: Google Finance

The rally in the middle of August could have been due to the overall optimism of Footsie investors. However, the Royal Mail stock outperformed the broader index. It climbed from around 180p to 217p in less than a week. But as of the time of writing, the shares are trading for around 172p. 

So, what does the future have in store for Royal Mail? Well, Goldman Sachs, one of the largest investment banks in the world, predicts a share price of 230p. But do the fundamentals signal a strong buy?

Royal Mail fundamentals

My colleague Edward Sheldon wrote a wonderful article on the company’s earnings results. No doubt, they were quite discouraging. Royal Mail was definitely among the companies to suffer from Covid-19. One of the reasons was the substantial decline in the volume of letters sent. But after having studied the company’s results in a bit more detail, I realised there was also a one-time factor. Royal Mail is enjoying higher demand for parcel deliveries with all this internet shopping we are doing. Here’s an excerpt from the financial report: “Parcel volumes up 2 per cent, lower than expected, due to threat of industrial action (Q3) and impact of COVID-19 on international import volumes (Q4). Parcel revenue up 4.6 per cent, due to targeted pricing actions“.

All that doesn’t look nice. But it seems to me that the threat of industrial action was rather a one-off. So, the next time the company reports earnings, we will see a rise in the revenue from parcels delivered, I think. Although many coronavirus-related restrictions were cancelled, it looks like many lockdown habits are here to stay. People still like to order online. This means that Royal Mail’s customer behaviour patterns will probably stay unchanged for a while. But it also looks like the lower revenue streams from letter deliveries are also here to stay.

The company’s management admits Royal Mail is unlikely to be profitable in 2020–21. What’s more, its shareholders won’t receive any dividends. But the management took very important steps to increase efficiency. First, it adjusted the working process in a way to cope with the coronavirus reality we are in, including social distancing measures. But most importantly, the company took steps to get “leaner and fitter“. Not only does Royal Mail plan to make some of its non-functional higher level employees redundant, it’s also going to cut its capital expenditure. Although job losses always have bad social consequences, these cost reductions are clearly positive for Royal Mail’s financial health. On top of that, its cash pile totals £1.9bn, which management predicts will still be large in 2020–21.  

Here’s what I’d do

Although Royal Mail is clearly a large company with a brilliant past, I wouldn’t buy its shares just yet. I think an investor has to be patient and indifferent to market moves in order to buy the stock. In my view, a defensive investor would be far better off picking shares from The Motley Fool’s epic catalogue of exclusive reports.