Here are 3 ways we inflation-proofed our portfolio in this baffling stock market

Published Wed, Aug 3 20224:42 PM EDTUpdated Wed, Aug 3 20224:50 PM EDT

The market this year has been one of the most confounding ever. The worst first six months of a year since 1970 and then a bounce one month into the third quarter has forced investors to be nimble. Economic and geopolitical forces beyond our control shifted the investing landscape at key junctures in 2022. To deal with the twists and turns, we've overhauled the portfolio around three main themes to resist inflation and recession. We'll go deeper into each a bit later. But here's the high-level look. We hold energy companies because of their ability to generate strong free cash flows and return money to shareholders. To address slower economic growth, we hold recession-resistant consumer staples and health care names. For the long-term, we stick with high-quality companies exposed to strong secular growth trends that trade at reasonable valuations. We haven't gotten it right every time. But we have had the conviction to act boldly and make big changes to the portfolio to mitigate against the tremendous downturn in the first bear market since March 2020 (the month Covid was declared a pandemic), without losing sight of our objectives as long-term investors who believe stocks will recover. Before we drill down on each of the three themes, we want to set the table. Coming into this year, the S & P 500 rose nearly 27% for all of 2021, marking a third straight year of gains. The Federal Reserve was tapering the extraordinarily easy pandemic-induced monetary policy. Seeing the writing on the wall, Jim Cramer provided his 2022 investment outlook on Dec. 9, 2021. Wary that the Fed might have to tighten soon to deal with a mounting inflation problem — which was starting to prove anything but transitory — Jim set the Club's mantra in motion. We want to invest in companies that make things for a profit. Jim has always aimed to be in stocks that pay dividends and do buybacks. Energy companies In early January, stocks started their march lower to what, for now, has been the year's lows in mid-June. Relentless selling was building as Russia invaded Ukraine in February. Oil prices rocketed higher. We were in some oil stocks already but bought more. We love the fat dividends many of them paid. But we readily admit we should have trimmed some of our positions much earlier when oil prices peaked. Here's why we like energy stocks: The S & P 500 Energy Sector has soared nearly 40% year to date, while the overall S & P 500 index has dropped around 13% during the same period. Usually in a recession, oil wouldn't be a first choice because demand for energy tends to go down as the economy slows. But the Investing Club bought into oil companies because they pivoted their focus away from production growth to focus on returning money to investors through share buybacks and cash dividends, which provides a boost to investors during tough economic times. Coterra Energy (CTRA) increased the percentage of free cash flow it is returning to shareholders to 80% in its second quarter; up from 50% in the first quarter. Pioneer Natural Resources (PXD) and Devon Energy (DVN) are additional examples of energy companies we own that have strong free cash flow profiles and dividend strategies that return capital back to shareholders. Both companies actually pay some of the highest dividends in the S & P 500. Their stocks have performed well this year too, with PXD and DVN both up about 25% and 37% for the year, respectively. If energy prices fall, our energy stocks may get hit, but our holdings that are currently experiencing margin pressure due to high energy prices will get some relief. Remember, even if our energy stocks go down, they're paying us in dividends and buybacks to hang tight. West Texas Intermediate crude, the American oil benchmark, has fallen $90 per barrel in Wednesday trading from its 13-year-highs in March above $130. We aren't terribly concerned about oil price volatility because there's still a tight supply of oil globally. And if production can't keep up with demand, oil prices go back up, which serves oil and energy companies well. Consumer staples, healthcare In April, the Fed changed the game when dovish central bank officials turned hawkish and signaled aggressive interest rate hikes ahead to fight inflation. The Fed has certainly followed through. High-grading became part of the Club's vernacular, the idea of trimming and exiting stocks wrong for the environment and getting into inflation-resistant stocks that can weather tough times such as healthcare and consumer staples. That meant taking some near-term pain to reposition things for the longer-term trends. Here's why we like healthcare and consumer staples: We believe staying diversified in consumer staples and the healthcare sectors will be great defensive plays in an inflationary environment because even if consumer demand weakens due to inflation or a hawkish Fed that results in a deeper recession, demand in these sectors should sustain due to their critical nature. Consumer staples like Procter & Gamble (PG) will be the last place consumers cut spending because they still need to buy the company's products, even in an economic slowdown. This is why we see P & G as a recession-resistant stock. What we like about Procter is that it can increase prices to offset rising costs. Like Procter, we hold Johnson & Johnson (JNJ) in a similar light and believe it can perform well as inflation rises because consumers will probably not pull back on J & J's products. After all, there are several areas to cut spending on before you pull back on pharmaceuticals and lifesaving medical devices. Club holding, Eli Lilly (LLY) is another high-quality defensive name. The reason why Eli Lilly is a great holding is for its innovative pipeline of treatments. Consumers will probably cut back in other areas before they stop purchasing Eli Lilly's medicines. The company may have to weather through higher costs this year, but we own the drugmaker for its bright prospects in its FDA-approved type 2 diabetes drug tirzepatide, which is also in trials to double as an obesity treatment. High-quality names We had to make this more defensive pivot because the case for modest Fed rate hikes was well and truly off the table, and anything remotely sensitives to higher rates was about to take a leg lower. The Fed hikes rates 25 basis points in March, 50 basis points in May, and then it did back-to-back 75-basis-point increases in June and July. While lightening up on high-multiple tech stocks that were slammed with higher rates, we are holding on to some core giants that just reported some terrific earnings. Here's why we're sticking with high-quality names: While we have defensive positions in the Charitable Trust, we also have room for high-quality names that may be impacted by inflation in the short term but can perform well during an economic slowdown. These companies consistently find ways to reduce costs and in many ways are the solution to inflation. Last week, Amazon (AMZN) reported better-than-expected second quarter revenue and increased its guidance . We see Amazon as a long-term hold because it delivers strong revenues from its Amazon Web Services cloud business. Companies will continue to invest in the cloud despite rising prices in the economy, which is why we see growth ahead despite slower consumer spending. Even if AMZN stock has a weak period, its fundamentals haven't changed. You are still investing in one of the best companies in the world. Apple (AAPL) released strong earnings in its latest quarter, showing that iPhone demand held up strong and that supply chains weren't as bad as anticipated. Slower sales from China were expected due to Covid lockdowns, but revenue from China fell only 1%. Apple is feeling the recession a little bit less. But in the event AAPL stock temporarily goes down, this is not a reason to sell. Apple is a high-quality company that generates high cash flows, has recurring revenue streams, a strong balance sheet and customer loyalty — all of which protect investors to ride out a drop in the stock's price. We stick with our mantra on Apple, "own it, don't trade it," because it offers exposure to quality growth, can deal with macro headwinds and has many future growth prospects. We also received better-than-feared results from Microsoft (MSFT). Thanks to software investments that have increased efficiencies in how the company operates its server and network equipment as well as advances in technology, management told investors it has managed to extend the useful life of server and network equipment assets in its cloud infrastructure from four years to six years. As a result, Microsoft expects to realize a $3.7 billion tailwind to operating profit in the current fiscal year. Microsoft also had strong cloud numbers. Now here we are, moving higher off the mid-June lows and wondering if the recent bounce is a bear market rally, which could put us right back into the soup, or the start of a real market recovery that can last. In his Sunday column this week, Jim said he believed the analysts have finally turned negative and we're seeing a bottom. Whether that proves to be the bottom of this bear market remains to be seen. — Members can get Jim's most updated view on the markets and all 33 stocks in his Charitable Trust, whose holdings serve as the Club's portfolio, during Thursday's "Monthly Meeting" livestream , which begins at noon ET. (Jim Cramer's Charitable Trust is long CTRA, PXD, DVN, PG, JNJ, LLY, AMZN, AAPL, MSFT . See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

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