Hit the gas on undervalued stocks before the Fed hits the brakes

By Constantine Lycos


As I write this on Oct. 15, 2022, it is common knowledge that we are looking at a potential recession
for next year.

I would argue that we are already in recession in 2022, as defined by world negative output growth, measured in
actual goods and services produced in 2022 vs 2021. Or measured in GDP in U.S. “constant” dollars, in other
words, adjusted for inflation. The main reason for that is that:

GDP = c * E

GDP is the world gross domestic product measured in constant dollars,

E is the total world energy from primary sources (such as biomass, coal, oil, gas, hydro, wind, solar)


c is an energy conversion efficiency co-efficient that tends to go up a little every year due to human innovation.

Simply put, it takes energy to make stuff. Work by hand requires food, factories need electricity or natural gas or
some other source of energy, etc. The world in 2022 is already in an energy crisis of sorts, self-inflicted for the most part. Investment in fossil fuel exploration dropped, as did oil and gas production, while simultaneously Germany and others shut down their nuclear power plants.

Meanwhile, Russia and Ukraine through war are taking out most of Ukraine’s grain production and reducing Russia’s exports of raw materials that can be converted to useful things outside of Russia.

Additionally, as the COVID lockdowns led to lower production of goods and services (less stuff) and central banks provided massive monetary stimulus (more money), high inflation ensued. So now, central banks are raising interest rates to fight the inflation they created. Under these conditions, the most important advice that I have had for people since the beginning of this rate-hike cycle has been: Don’t fight the Fed!

We will continue with that theme.

My sense is that we are getting close to the end of this period of rate hikes as asset prices such as stocks and real
estate have fallen off, as have commodity prices. Inflation has not dropped, due to the more sticky aspect of things
including rent, wages, and homeowners' equivalent rent. Such items take more time to react to market changes.

With that in mind, we are going to stick to high-quality, recession-resistant businesses with decent dividend yield,
and throw in a stock to take advantage of the time when central banks pause with their rate raises. At that point, the stocks that have performed well as borrowing rates increased should stop performing as well, and stocks that
have been beaten down will perform better.

This month’s top 3 stock picks:

1. Imperial Brands PLC (OTC: IMBBY $22.76 – don’t pay over $24)

Imperial Brands is the world's fourth-largest tobacco company. It is no secret that their business has been in
decline. This has been the case for the last two decades, but the numbers are fairly stable now. The valuation is very good. They pay a decent dividend. And this sort of business is less affected by economic cycles. So it's a good one to hold while waiting for conditions to improve.

2. Merck & Co., Inc. (NYSE: MRK $92.18 – don’t pay over $96)

Merck is another recession-resistant type of stock – a pharmaceutical company. Again, people don't cut down on
their prescription medications, regardless of the economic cycle. So these sorts of businesses tend to be less affected by economic cycles. The large-cap pharmaceuticals that pay a decent dividend are attractive in the current investment environment. Valuations in this sector are never particularly good, so not ideal from that perspective. We do not expect to make a huge return, but they could be a nice stabilizer in a well-diversified portfolio. Merck (NYSE: MRK) is my top pick among pharmaceutical firms because of the solid dividend yield, and I believe their products are comparatively stable.

3. Barrick Gold (TSE: ABX $19.66 – don’t pay over $22)

We do not know when the Fed (Federal Reserve Board) will pause – it could be in three months time, six months time – and it could be earlier. Regardless, when it happens, the path to investment profits could be lined with gold. Barrick Gold is the second largest gold miner in the world after Newmont.

Gold miners are producing these days at an approximate cost of $1,000 per ounce or a little bit over. They have essentially a licence to print money because with world gold prices around $1,650 per ounce at the time I wrote this, Barrick is already reaping large profits.

Now, of course, while the Fed is raising rates, the U.S. dollar is strengthening, and people have an incentive to hold short-term Treasury instruments, money-market funds, and vehicles that pay decent interest – as opposed to gold, which pays no interest. So we don't expect the price of gold to go up until the Fed hints at pausing interest rate hikes.

The U.S. dollar, on the other hand, is expected to keep rising until that pause happens. At some point, that trend
will reverse. Because you can't know when that will be, it is important to have a diversified approach and be there
ahead of time. Barrick is a good pick for having an offensive position when the Fed pauses. Disclaimer: Performance of stocks is, of course, never guaranteed. Consult a professional financial adviser before investing in these or other businesses.

(Constantine Lycos is the CEO of Lycos Asset Management Inc., which provides financial advisory services including portfolio management to individuals and corporations. He can be reached at constantine@lycosasset.com or 604-288-2083. Visit lycosasset.com for more information.)