3 Stock Picks for a Contracting US Economy

The weak economy could well be sneaking up on us and the rest of the market. In part, the market is being propped up by a flood of mergers and acquisitions. Meanwhile, those companies not buying or getting bought out are raising debt to buy back stock their own stock.contracting-us-economy
Both are trends that won’t last forever. The six-year-long bull market in stocks is looking a bit long in the tooth. To start, higher interest rates will put a cap on the amount of debt companies are using to make acquisitions and do buybacks. But there are other factors at work here too, including weak growth in the economy and a plateauing of unemployment reduction.
Last week, we found out that the U.S. economy actually contracted during the first quarter of 2015. Specifically, gross domestic product contracted at an annual rate of 0.7%. That’s also well below the 0.2% fall that economists were previously expecting.
All around, things are pointing to a slight reset for the economy. It wasn’t just GDP, we also had weaker than expected factory activity in May and consumer sentiment that is at six-month lows.
So, where do investors head from here? Strong balance sheets and companies generating strong returns on equity are places to start. But the key is to find business models that will still be profitable and have products or services that are needed when economic growth slows. Here are three stocks that fit all of those criteria:
Contracting Economy Play No. 1: Johnson & Johnson (NYSE: JNJ)
Procter & Gamble (NYSE: PG) gets a lot of the focus when it comes to the consumer staples space, but Johnson & Johnson is the leader in the more stable health-care industry. Most notably, Johnson & Johnson is a big player in the growing pharmaceutical and medical devices market.
The pharma arm of Johnson & Johnson is often overlooked for the company’s consumer products. But the company believes it can create 10 new drugs by 2019 that have the potential to generate over a billion dollars in sales each. On the medical device side, it has already created various minimally invasive surgical tools. And unlike other pharma companies, Johnson & Johnson’s other products and businesses help insulate it from major patent cliffs. You’ll still be paying for health-care products and consumer staple products when the economy slows.
The health-care products company also offers a 3% dividend yield and has upped its annual dividend for 52 straight years. Its payout ratio is also just around 50%.
Contracting Economy Play No. 2: Union Pacific (NYSE: UNP)
Traditionally an economic bellwether, when the economy does poorly, you’d expect rails to take a hit. But don’t you still eat and buy other necessities? The bulk of Union Pacific’s cargo is agricultural commodities. It also does a fair amount of coal cargo, which is still widely used in electricity generation.
It also just so happens that Union Pacific is one of our wide moat companies, the type that Warren Buffett loves. Union Pacific’s moat lies in its large network of rail track in the West. The rail company also offers a 2.2% dividend yield, with just a 35% payout ratio. It has been paying a dividend for 35 years.
Contracting Economy Play No. 3: MasterCard (NYSE: MA)
We’ve talked about MasterCard a lot, it seems. For good reason. The stock has had a run that’s been nothing short of impressive, outpacing the S&P 500 by nearly 280 percentage points over the last five years.
As we noted almost a year ago, MasterCard is a great rally stock that should keep making new highs. And make new highs it has. Shares are up 25% in just under a year, outpacing the S&P 500 by over threefold. Just because a stock trades near all-time highs doesn’t mean it won’t keep going . . . specially when you have the type of moat and growth opportunities that MasterCard has.
Now, MasterCard isn’t a grand ole dividend play, yielding just 0.7%. But you’re buying the stock for the strong tailwinds, which includes the shift toward mobile payments, as well as a rise in card payments in emerging markets. People will continue to spend money regardless of the economic backdrop — the only change being what they spend it on.
In the end, will the market crash next week? Next month? No one really knows for sure, but the takeaway is that the data are pointing to a weaker economy going forward. The three stocks above are positioned nicely for when we do see a reset.

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