MW Why this fund manager is fighting higher inflation with dividend stocks

By Mike Clarfeld

These high-quality, dividend-paying stocks in 3 sectors stand to benefit from rising prices

Trump's economy should entail higher wages, higher consumer spending and higher U.S. growth - but also lower margins, higher inflation and higher interest rates.

Since the November election, investors have piled into U.S. market sectors expected to benefit from the second Trump administration. Yet as the joy of these quick gains subsides, they will have to think through the second-order effects of Trump's presidency and position their portfolios accordingly.

A second Trump presidency should be good for domestic energy production, but is higher production good for energy prices and producer profits? Trade tariffs should raise import prices and encourage manufacturers to bring operations back to the U.S. But if corporations moved those jobs overseas to cut costs and save money, doesn't bringing them back invariably mean rising costs and lower profits? Deporting millions of undocumented immigrants may prove politically popular, but won't removing millions of workers from a tight labor market lead to higher employment costs and inflation?

One thing seems clear: To the extent that Trump is successful in bringing manufacturing jobs home and sending undocumented immigrants packing, inflation will be permanently higher.

Deglobalization and inflation ahead

There is no way around it - globalization benefited U.S. investors at the expense of U.S. workers. Deglobalization will certainly have some benefits. By some measures, the middle class has seen little real wage growth in several decades. Bringing back manufacturing jobs will be good for U.S. workers. Increasing labor costs will reduce margins and come directly out of shareholders' pockets, but it will benefit society as it reduces inequality. Reshoring manufacturing could also result in structurally higher U.S. GDP growth with higher wages leading to money shifting to the middle class - a group with a higher propensity to consume than the wealthy. This would propel economic activity.

As the market processes Trump's victory, economic data has been better than expected. While it previously seemed a slowing economy would give the U.S. Federal Reserve space to cut interest rates, recent data suggest the economy remains robust. The combination of healthy economic data and Trump's election win have shifted expectations, and interest rates are now projected to be higher through 2025.

With the market at all-time highs, valuations on the fuller side, and interest rate expectations becoming less dovish, investor positioning must become more nuanced. A healthy economy, lower taxes and less regulation should help corporate earnings in 2025. But parsing the net impact of Trump's presidency is complicated. His economy should entail higher wages, higher consumer spending and higher U.S. growth - but also lower margins, higher inflation and higher interest rates.

Higher growth, higher wages and reduced inequality are invariably good for the top line and good for society. But lower margins, higher inflation and higher interest rates all augur for lower multiples on investments.

Quality counts

Dividends account for 40% of the U.S. market's total return over the long term.

Against this backdrop, there's a strong case for shares of high-quality dividend payers - companies that are typically leaders in their sectors, with strong balance sheets, low debt, recurrent predictable revenues and economic moats. Such companies boast three key and timely attributes: downside protection, current income and growth.

Downside protection: After a two-year period in which the market has soared, stocks may be extended. Dividend payers tend to outperform during turbulent periods as investors gravitate toward the safety of their healthy payouts.

Current income: In big bull markets, people tend to overlook dividends. But bear markets remind us that dividends account for 40% of the U.S. market's total return over the long term. In flat-to-down markets, meanwhile, dividends provide a cash flow return to investors that offsets share price stagnation or depreciation.

Growth: While strong upfront yield is attractive, the real power of equity is in its long-term compounding and growth. Unlike bonds, which typically offer fixed coupons, dividends have the potential to offer rising cash flow streams over time. Dividend growth is great in regular periods, but absolutely critical during inflationary periods. As inflation erodes the value of a dollar, growing dividends help to maintain purchasing power despite the increasing cost of living.

Three sectors to consider now

In a market myopically focused on a few technology stocks, investors may find opportunities to target dividend growers in more value-oriented sectors. Cyclical sector representation is near a 100-year low, and the market may be at the tail end of a trend that started 40 years ago when interest rates peaked.

Three sectors offer the opportunity to actively diversify exposure away from higher-multiple stocks to dividend-friendly sectors underweighted in the broad market.

Energy: With energy production poised to benefit from a supportive regulatory regime, midstream operators of pipelines and related infrastructure, which offer a combination of strong upfront yields and a tendency toward contracts with built-in inflation escalators, are poised to benefit. Two stocks that meet this description are Enbridge Inc. $(ENB)$ and Williams Cos. $(WMB)$.

Financials: The financials sector should benefit from reduced regulatory pressure and positive leverage to rising interest rates. Banks, for example, directly benefit from higher interest rates as they raise the rates they charge to borrowers. Stock picks in the financials category include MetLife Inc. $(MET)$ and $Capital One Financial Corp(COF-N)$. $(COF)$.

Consumer staples: Consumer staples have significantly underperformed as they lapped comparisons from the COVID-19 era when people stayed home and prices soared. A robust business cycle and healthier long-term wage growth should result in better long-term demand and earnings growth for stocks such as Nestle S.A. (NSRGY) and Unilever $(UL)$, for example.

Mike Clarfeld is a portfolio manager of the ClearBridge Dividend Strategy Fund SOPYX.

More: 'Inflation levels seem to be increasing': Businesses are worried about tariffs and rising prices.

Plus: Why investors should watch the dollar as markets make sense of Trump's tariff plans

-Mike Clarfeld

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January 11, 2025 11:38 ET (16:38 GMT)

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