Market Is Dropping: 4 Buys In Case We See Further Declines

Tourist with bagpack walking through meadows

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Main Thesis & Background

The purpose of this article is to discuss four equity positions that I have initiated in the past week. As my followers know, I had been building up my cash position over the past month. With the market selling off en masse, I believe it is time to put some of that cash back to work. In normal times, I would plow that in to mostly the S&P 500, dividend equity plays, international developed markets, and municipal bonds. Going in to 2022, I only owned a handful of stocks, as I mainly invest in ETFs and CEFs.

With 2022 being such a poor year for broad equity positions, I wanted to take this opportunity to get a bit more creative and defensive. Sure, I could buy back the positions I sold at better prices, but I am concerned we may have more pain on the way. There are macro-headwinds facing the U.S. and the globe that do not seem to be resolving themselves any time soon. As a result, I have dipped in to three new individual stock positions and have added to a fourth, with the intention that these names will fare better than the broader market if equity declines continue going forward. I will discuss all four positions and the reasons behind my outlook in this review.

Buy #1: Dollar General (DG)

The thought here is a simple one. I picked up Dollar General (DG) because to me this is the perfect “recessionary” play. As American consumers are gravitating toward less expensive stores as inflation drives up rent, food and fuel costs, stores like DG are set to see continued rises in sales. Ultimately, core goods and staples need to be purchased regardless of the broader economic state. The difference is consumers will look for cheaper options and alternatives, or even just stores that offer the same product for less (i.e. dollar stores). This has been a common-sense trend so far in 2022, with revenue rising for the company by 9% in the second quarter on a year-over-year basis. Similarly, profit grew more than 7%, according to the company’s most recent financial filing.

DG's Q2 Financial Report

DG’s Q2 Financial Report (Dollar General)

I simply see this as a consumer momentum play that will continue through the end of the year. Despite oil prices being on the decline, inflation remains a top priority for American households and one that has been more stubborn that most market participants predicted. This has put the American consumer in a very tough spot, and one they are not very happy with. Confidence has plunged as 2022 has gone on, and that tells me there is going to be some serious penny-pinching in the short term:

Consumer Confidence Index

Consumer Confidence Index (U.S.) (The Conference Board)

While this is not “good” news by any means, it does bode well for budget stores like DG. With Americans facing the possibility of a prolonged period of high prices, expect them to be more and more conscious with where they spend their money. That could work directly in favor of DG.

Buy #2: Waste Management (WM)

There is a commonly used expression that I think is relevant here: Trash Is Cash. When talking about Waste Management (WM) , a comprehensive waste, and environmental services company, I think that expression rings very true.

This is not that novel of an idea, as many investors have clearly been on board with it as 2022 got underway. While the broader market is deep in the red, WM has managed to squeeze out a minor gain, as shown below:

Chart: While the broader market is deep in the red, WM has managed to squeeze out a minor gain

YTD Performance (Google Finance)

I think there are multiple reasons for this defensiveness that I want my portfolio to take advantage of:

  1. This is a “necessity” service

Americans can’t live without trash removal. When it comes to cutting back, local governments, municipalities, and households cannot live without this service. That makes it about as defensive as one can get and, in this climate, having a dependable revenue stream screams “buy” to me.

2. Revenue is domestic

With all the macro-risks going on in the world today (i.e. Russia/Ukraine, China/Taiwan), it makes sense to have a dependable, domestic-oriented company in my portfolio. WM is a North American company that generates most of its revenues here at home. That makes it less sensitive to trade, war, and supply-chain risks, and will very well balance out a portfolio that is more global in-scope when we think about large, multi-national U.S. companies.

3. The company can pass-through costs to consumers

Similar to #1 above, this type of necessity service gives the company a greater ability to pass-on higher costs to its customers. Similar to utility companies, sometimes these fee increases have to be improved, but WM has plenty of leverage when it comes to these negotiations given the service they provide. As a recent example, Sebastian City in Florida has agreed to a 15% increase in service price for its residents, set to take effect October 1st:

Local Headline (Sebastian City, FL)

Local Headline (Sebastian City, FL) (TC Palm News)

What I am getting at is that WM has been performing well for all the right reasons. It offers a service households can’t live without, has some pricing power, and generates its revenue and profit in a way that is immune to some of the biggest geo-political risks facing the globe. Throw in the sustainable / recycling theme, and this one seems like a no-brainer to me.

Buy #3: McDonald’s (MCD)

Another great recession theme for me is fast food. McDonald’s (MCD) is obviously a global leader in this space and will be poised to capture the cheaper dining trend that is sure to sweep the nation as food costs remain elevated. On the one hand, supply-chain problems and rising input costs hurt the company, so this is by no means a “sure thing”. However, the prices for dining out are up across the board, and McDonald’s has an edge when it comes to providing cost effective, quick menu items.

This is actually a stock I recommended a long time ago, and it has never failed to disappoint. Through it has its ups and downs like any other company, you can see it has handily beaten the S&P 500 when I recommended it roughly nine years ago in a Seeking Alpha article:

McDonald's (<a href='https://seekingalpha.com/symbol/MCD' title='McDonald's Corporation'>MCD</a>) Stock Performance

Stock Performance (Seeking Alpha)

With this stock, there are also a number of reasons why I like it. The first has to do with the recession, cheap-eatery option noted above. Another has to do with company management and its commitment to returning cash to shareholders. MCD’s is known as a “Dividend Aristocrat” stock, with over 20 years of consecutive dividend increases (annually). This is by no means a high yielder, but rather a slow and steady way to increase an income stream:

McDonald's (<a href='https://seekingalpha.com/symbol/MCD' title='McDonald's Corporation'>MCD</a>) Dividend History

MCD’s Dividend History (Seeking Alpha)

As a “Dividend Seeker”, this is certainly a metric I find desirable and needs very little justification in my view!

Another point to consider is similar to my take on WM. MCD’s has some pricing power, albeit at a lower extent to some other less discretionary areas. But, as an example, just Monday (9/26), MCD announced it would be raising prices on a number of items in its Japan stores, as reported by Reuters:

snippet on McDonalds Raising Prices

McDonald’s Raising Prices (Reuters)

This again tells me this is the type of exposure I want – a company that has the ability to force its end users to bear some of the brunt of inflation.

A final thought on MCD expands beyond just this company but to fast-service restaurants as a whole. As more Americans are (finally) getting back to work, I see this as a driver for demand for these types of establishments. As more people begin commuting again, this increases the demand for on-the-good food options and drive-through consumption. MCD fits in to this demand cycle very nicely. And the best part is I see brighter days ahead because even though labor force participation is rising, we still have ways to go before it is back to pre-pandemic levels:

Labor Force Participation Rate (US)

Labor Force Participation Rate (US) (St. Louis Fed)

I see this as one of a number of factors that is bullish to MCD, and I feel very confident in its inclusion in my portfolio.

Buy #4: Smith & Wesson (SWBI)

My last pick-up is Smith & Wesson Brands (SWBI), which is a firearms play. This is slightly different than the other three, but I think having this exposure during times of uncertainty and civil unrest can end up being profitable.

Simply, when times get tough, people think more about protecting themselves. When the U.S. had countless riots in 2020, SWBI saw sales soar. Things have come back down to Earth since then, but I personally feel we are just one major news headline away from a similar outbreak in many U.S. cities. Crime, especially violent crime, has been on the rise, and more Americans are electing to purchase firearms to keep themselves and their families safe.

Again, this is another trend we have seen for a while, but it has been more sustainable than I could have imagined. We have seen gun sales by month hover near the 2-million mark, well above the 1-million mark in years past:

Bar Chart: Gun Sales in America

Gun Sales in America (NBC News)

All these sales are not SWBI, of course, but many are, and this discretionary spend by Americans is helping the company drive revenues and profits in a more sustainable way than it has in the past.

In fact, 2020 and 2021 were such strong years the company has been hiking its dividend rather aggressively. While nowhere near “aristocrat” status like MCD, the current yield sits near the 4% mark, quite enticing in this environment.

I also see a strong catalyst for sales in the short-term. A recent announcement by the major credit card companies to enforce a new merchant category code that will identify transactions at gun shops in the United States has been met with both support and derision by the populace. To me, I see gun sales getting a boost as consumers try to front-run this decision before it is properly and fully implemented by the credit card companies and their merchants. This bump in potential sales should directly benefit SWBI.

Why Not Just The S&P 500?

I will wrap up this review by highlighting the basis behind the why of these buys as opposed to just adding to my broad market (mostly S&P 500 dominated) funds. Clearly, the market has sold-off in a big way, so most stocks/funds/sectors/themes look cheap on a relative basis. A logical way to play this could be to simply add to a S&P 500 fund like the Vanguard S&P 500 ETF (VOO) and call it a day. To be fair, that is what I have done many times in the past and see no real “problem” with doing it now. Buying the S&P 500 in correction and bear market territory is a long-term winning play and it could certainly be the right move for many at the moment.

The reason why I hesitate at this juncture is simply I don’t see volatility slowing down and I want to take a more defensive positioning for the time-being. This is a subjective concern, and other readers could vehemently disagree. That is what makes a market. The main issue I have is that the S&P 500 is very volatile right now, which tells me that getting more creative might be a better “sleep well at night” idea. For example, all three major indices have seen wild swings over the past two months. The number of days where there has been at least a 1% move in either direction is very large:

Chart: Stocks Have Been Volatile

Stocks Have Been Volatile (Bloomberg)

Again, this doesn’t make index investing “bad”, it just means it is more volatile right now. That spells opportunity, but also risk. For me, I have plenty of exposure to all these indices and I felt the need to branch out a bit to balance that out. I feel confident the four names I mentioned above will help me do that with my portfolio. My goal is to protect some of the cash I had raised with these more defensive and creative names if times continue to be difficult. I hope this provides readers with some food for thought, and ways they may be able to similarly protect themselves in what has been a difficult calendar year.

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