Last week central banks in the US and UK raised base interest rates by 75 basis points. This is to try and tame high, persistent inflation, or even stagflation.
The British economy is not growing, so could be considered stagnant. Meanwhile, inflation means goods and services such as food, are rising. When both situations occur and persist, we have stagflation. It is often accompanied by rising unemployment, something we have yet to see.
On paper my equity-skewed portfolio may look doomed. However, my analysis of past market shows there may be a silver lining for some equities. This is certainly the case for one FTSE 100 stock.
Higher rates and the stock market
Central banks raise interest rates to cool inflation. Inflation compels central banks to raise rates more aggressively. In a higher interest rate environment companies are faced with simultaneous falling revenues and rising costs. This combination squeezes profit margins. However, I believe some idiosyncrasies to this rule exist.
In my experience, stagflation tends to favour defensive, value-oriented companies that sell products and services essential to people’s everyday lives. For example, whether inflation is high or not, people still need to purchase food, pay their electricity bills and rent. This means the share prices of such companies tend to hold up better when the economy slows.
A FTSE 100 stock that can deliver
Needless to say, I do not intend to base my investment decisions on past performance. But I do think the case for defensive, value stocks has been particularly strong over this business cycle.
It comes down to a simple logic of mine. Defensive sectors have a market beta (volatility) of less than one (meaning they outperform when the index falls). I find lower volatility stocks most attractive in the current climate.
One FTSE 100 stock covering all these characteristics is British American Tobacco (LSE:BATS). The stock has had a great run this year, up 20%, boosted by the flight to defensive stocks from growth stocks. I think the run will continue.
Furthermore, I view the company as one of the best dividend payers in the FTSE 100. It is offering one of the highest yields (6%) currently.
The timing for me to buy now seems ripe, with the stock price losing ground recently. This may be due to a number of factors. Rising borrowing costs, people smoking less, and an earnings growth decline are all notable headwinds.
Contrastingly, I believe the FTSE 100-listed company is able to use its pricing power to try and offset the impact of declining tobacco volumes. While I also think the aggressive expansion of its non-cigarette business will support its dominant market position.
The business of tobacco is sticky — smokers often see their purchases as necessary rather than discretionary. This is why it is a go-to FTSE 100 stock for me in a low growth environment.
No time to panic
Ultimately, investing for stagflation is understanding that it is not likely to last forever.
While my portfolio may take a hit in the near term, I am confident that my long-term investment strategy will ensure it recovers.
In the meantime, the addition of the stocks like British American Tobacco can help smooth my returns. It is a stock I will be adding to my portfolio before long.
This post was originally published on Motley Fool
