Hedge fund manager Lukas Tomicki believes investors aren’t taking inflation risks seriously enough.
With inflation still hovering above 3%, well above the Federal Reserve’s 2% target, the central bank is seeking to further stifle demand by keeping interest rates high following one of the most aggressive rate-hiking campaigns in history.
Despite high interest rates and persistently high inflation, stocks are up 12% so far this year and 26% over the past 12 months.
But good times won’t last forever, and inflation will likely push down stock prices at some point in the future, Tomicky said.
“I think the market is very complacent about this,” Tomicki, founder of LRT Capital Management, told Business Insider in an interview on May 17. “We had a big inflation-fueled rally earlier this week on Wednesday, but if this was two years ago, I think the market would have fallen 3%. And now, for some reason, everyone thinks this is a great inflation rate.”
“I’m very pessimistic. We’re very hedged,” he continued. “The market could easily fall 20 to 30 percent from here.”
Mr. Tomicky said he expects an eventual recession as government debt and spending rises and home prices remain the most unaffordable in decades, but his view on the stock market depends heavily on where inflation and interest rates go.
He believes inflation will remain higher than the Fed would like because of rising oil prices amid ongoing geopolitical conflicts. Oil prices play a large role in fueling inflation and shaping inflation expectations because they affect transportation costs, which in turn feed into commodity prices.
Rising inflation “shatters people’s expectations of interest rate cuts, which leads to higher interest rates in the bond market,” Tomicky said. When inflation remains high, investors start demanding higher yields on their bonds to make up for the value of their money, which will decline over time. And the higher the risk-free yield in the bond market, the more attractive Treasuries become relative to riskier stocks, and the lower investors will generally pay for stocks.
Tomicki said a rise in the 10-year Treasury yield to 4.75% from its current level of about 4.4% would trigger a sell-off in the stock market. He pointed to the fact that the 10-year Treasury yield and the S&P 500 have been moving in opposite directions in recent months as evidence that the movements of the two asset classes are correlated.
“I think it’s up to the governor to decide where the stock price goes,” he said.
Tomicky’s bearish view is unusual on Wall Street, where most strategists and economists are brightening their outlooks as the economy remains strong.
The average price target for the S&P 500 by the end of 2024 from strategists at the biggest Wall Street firms is over 5,000. Even Morgan Stanley’s Mike Wilson, one of Wall Street’s most bearish strategists in recent years, raised his price target to 5,400 from 4,500 earlier this week. JPMorgan’s Marko Kolanovic is one of the few remaining bears, predicting a 20% drop in the S&P 500.
Five defensive stocks Tomikki is betting on
Tomicky said his pessimistic outlook for both stocks and the economy has led him to put his money into more defensive stocks that are less vulnerable to economic fluctuations.
The first company Chemed Corporation (Choi)The company is a hospice-care company that also recently acquired plumbing company Roto-Rooter Inc. Both industries are relatively unaffected by an economic downturn, he said.
“People are dying, they need hospice care, they need plumbing and drainage repairs, regardless of their economic situation,” he said.
The second one is RLI (RLI)specialty insurers. Not only will insurers be less vulnerable to recessions, but they will also benefit from rising interest rates by investing the premiums their customers pay.
“In an environment where interest rates remain high for extended periods, investors are continuing to shift their investment portfolios towards higher yielding portfolios,” Tomiki said.
Third, Tomicki Wyndham Hotel (White)is a budget hotel company that owns brands such as Ramada, La Quinta, Super 8, Days Inn and Travelodge. He said the lower end of the hotel industry is less vulnerable to economic downturns because it focuses on business travel and has fewer vacationers, which is a more cyclical part of the hotel business model.
Fourth, Tommy Dollar General (President)a low-cost retailer. The stock is in the consumer staples sector, selling products that consumers need even in tough economic times. He finds the stock attractive as it’s down 45% from its 2022 highs and inventory is starting to normalize as the company moves to reduce the products it sells.
Finally, Tommy loves cosmetics companies. Estee Lauder (Elle)Like Dollar General, the stock is in the consumer staples sector. But Tomicky said he thinks the company’s management is in the process of making changes to correct declining earnings and stock price, which have fallen 64% since December 2021.
“What happened at Estée Lauder is a unique issue that they’re going to address,” he said. “The very simple things they’re going to do to normalize inventory levels and better match supply and demand will lead to revenue growth going forward. I’m pretty confident about that no matter what the economy does.”
