How do you decide what stocks to invest in when the record-long nine-year-old bull market could be ended by global trade wars and rising inflation? That’s what a lot of nervous investors are asking. But top investment strategist John ­Osterweis says there are ways to prepare your investment portfolio for any outcome, good or bad. For him, it’s about picking stocks and sectors that can ride the market higher if the economy continues to surge…but also survive and do well if economic growth slows and stocks stumble.

Bottom Line Personal asked Osterweis how investors should view the current environment and what characteristics he looks for in stocks now…

The Challenges

I’ve been called a worrywart my entire career because I focus on what could go wrong even in good times. The biggest potential stumbling blocks right now: An escalating trade war, especially between China and the US, and fast-rising inflation. Both could hurt business confidence and force the Federal Reserve to raise interest rates more aggressively. Typically, sharply higher rates put the brakes on economic growth and are the most common killers of bull markets.

It’s difficult to predict how these twin threats will play out and how quickly. As of early September, the Trump administration had placed a 25% tariff on steel and a 10% tariff on aluminum imported from nations including Mexico, Canada and the European Union (EU). Those countries had retaliated with tariffs on US imports, but the US negotiated a new trade deal with Mexico, resumed negotiations with Canada and continued talks with the EU.

The situation with China has been much more troubling. The US threatened to impose tariffs of 25% on $200 billion worth of Chinese imports on top of an initial $50 billion worth of tariffs on Chinese goods such as flat-screen TVs and medical ­devices. China responded with tariffs on US goods of equal value ranging from soybeans to automobiles to lobsters.

The best-case scenario is that the administration’s very aggressive trade rhetoric proves to be a successful negotiating tactic, getting China to reform unfair trade practices with the US, including increased respect for intellectual property rights of US tech companies. But if the situation devolves, a trade war involving hundreds of billions of dollars of goods would disrupt supply chains for US manufacturers and damage American business confidence. That could lead companies to reduce capital investments and could ignite higher prices for US consumers on many everyday goods, stoking inflation.

Even if trade wars don’t spin out of control, inflation could spike as a consequence of the robust economy as the stimulative effects of the federal tax cuts continue to kick in. The Consumer Price Index, a proxy for inflation, was up 2.9% year over year in July after ending 2017 up 2.1%. And worker shortages are pushing up wages for certain jobs such as truck drivers and airline pilots.

Best-case scenario: Overall wages continue to grow slowly, and interest rates rise modestly at a measured pace, allowing the economy to continue to expand.

Worst-case scenario: Inflation really heats up and interest rates follow, sending the stock market into a potentially very deep bear market.

How to Invest

In the current environment, I’m guarding my downside by avoiding US companies that have products likely to take a direct hit from a trade war…to be significantly hurt by high inflation and interest rates…and/or to struggle badly in a recession. This means staying away from automobiles, housing, agriculture and most traditional land-based retailers.

Instead, I’m focusing on undervalued companies with the following characteristics…

  • Their primary businesses are domestic, or at least they have foreign operations unlikely to be affected by import-export tariffs.
  • They have strong cash flow and reasonable debt loads so that they won’t be crushed by higher interest rates.
  • They benefit from long-term catalysts for accelerating growth so their outlook isn’t heavily tied to the ups and downs of the overall US ­economy.

Five of my favorite companies now…

Air Lease (AL) leases its fleet of more than 250 aircraft to airlines in 56 countries. About 40% of all commercial jetliners are now leased, making it a ­lucrative and recession-resistant industry. During good times such as right now, when global air travel is booming, airlines need leased planes to meet increased demand. In down cycles and when interest rates are high, it’s cheaper for airlines to lease than to buy planes. Air Lease expects to increase its fleet by 50% over the next 18 months and already has lease contracts for most of those new, fuel-efficient planes when they are delivered. Recent share price: $46.55.

Crown Castle International (CCI) owns 40,000 cell towers across the US, offering long-term leasing contracts to wireless carriers such as Verizon and Sprint, which install equipment to support their networks. As the carriers roll out their networks, and more computing devices are embedded in homes to transmit data, Crown Castle can offer additional capacity on its towers, making them even more profitable. What’s really exciting is the company’s installation of 60,000 miles of fiber-optic cable to support network diversification, 5G and other uses in large urban areas. ­Recent share price: $113.76.

Danaher Corp. (DHR) is an industrial giant with steady earnings in more than two dozen US health-related niches, such as diagnostic tests for diseases and infections used in laboratories and hospitals…and environmental services such as the two billion–plus gallons a day of drinking water that it treats for New York City. These businesses generate strong cash flow even in rocky economic times. Danaher has been letting go of slower-growing, nonhealth-related businesses so that it can ramp up acquisitions to increase market share and pricing power in the health arena. Recent share price: $103.01.

Digital Realty Trust (DLR) is a real estate investment trust (REIT) that owns more than 200 data centers around the world, although it derives most of its revenue from large US ­metropolitan hubs. It is a dominant player in this REIT niche. Its huge, climate-­controlled warehouses filled with computer servers and data communications equipment are rented out to companies such as Amazon and Microsoft, which store vast amounts of digital data there. The demand for data storage will continue to surge as more businesses shift their services to the cloud, allowing this REIT to keep raising rents. Recent share price: $123.70.

NextEra Energy (NEE) is an unusual type of US utility company. Its regulated side distributes power to five million customers in Florida, producing steady revenues that aren’t likely to change much no matter what happens with global trade or inflation. And its unregulated subsidiary is the nation’s leading developer and operator of wind- and solar-energy facilities. Recent share price: $170.83.