April 5, 2023

A Banking Relief Rally

The market was impressive last week. The S&P 500 moved 3.5% higher for the week, accounting for nearly half of the better than 7% YTD return. Hopefully the rally has further to go.

Investors love it that the banking issues have had the benefit of tempering the Fed with no apparent offsetting crisis so far. The expected timeline for the Fed to stop raising rates has moved way up, to one more rate hike from what could have been a hiking cycle that lasted the rest of the year.

The end of the Fed rate hiking cycle is a big deal. Inflation and the consequently hawkish Fed are what drove the market into bear territory. While there may be more trouble ahead, the end of this crummy market should now come a lot sooner than expected just a few weeks ago.

But questions remain in a market that changes personality every couple of weeks. The timeline and severity of a possible recession is unknown. There could be more bank trouble. And it is likely that the Fed will keep rates high for a lot longer than investors seem to be currently anticipating.

The market seems to be pricing in Fed rate hikes later this year. That’s possible if there is a recession. But it is very unlikely that the Central Bank will lower the rate to anywhere near the extent as in recent recessions.

Sure, inflation has come all the way down to 6% from a high of 9.1%. But it is still a long, long way from the Fed’s 2% target rate. History is abundant with evidence that you can’t take your foot off the neck of inflation until it’s truly dead, or else it just comes back again in the next recovery. The Fed knows this and doesn’t want a decade-long mess, partially of their own making.

The recovery could be disappointing without the Fed juicing the market by lowering the Fed Funds rate to zero and leaving it there as it has in the past. It’s also possible that we don’t get a recession. It could be a period of stagflation ahead, with continuing inflation and slow growth.

There is the possibility of continuing inflation, recession, or perhaps stagflation ahead. But all these scenarios boost the relative performance of dividend stocks and income investments. Stocks are basking in the glory of the ending of rate hikes for now. The rally could last longer. But we are still positioned in mostly defensive stocks that can best weather the risks ahead.

Recent Activity

March 8
Medical Properties Trust (MPW) – Rating change “BUY” to “HOLD”
Eli Lilly and Company – Rating change “HOLD” to “BUY”
Xcel Energy Inc. (XEL) – Rating change “HOLD” to “BUY”
Visa Inc. (V) – Rating change “HOLD” to “BUY”

March 22
SOLD Medical Properties Trust, Inc. (MPW) - $7.40

Current Allocation
Stocks 30.2%
Fixed Income 20%
Cash 49.8%

High Yield Tier

Enterprise Product Partners (EPD – yield 7.5%) – There’s good news and bad news, rallies and selloffs. There’s inflation and talk of recession and recovery. The market changes personality month after month, and even week after week. But EPD just continues its slow slog higher. EPD also returned 18.4% in 2022 when the S&P was down 19.4% for the year. This year, it’s up 8% YTD. A high yield and earnings that are resilient in inflation and/or recession should continue to be a winning formula for the rest of this uncertain year. (This security generates a K-1 form at tax time). BUY

ONEOK Inc. (OKE – yield 6.0%) – This midstream energy stock had been pulled down in the wake of the banking situation. OKE pulled back below 60 per share. But the selling was likely overdone because this company continues to post strong earnings and is well suited to endure inflation or any kind of economic slowdown that might be coming down the pike. The stock has already popped back above 65 per share and could very well continue to move higher. BUY

Realty Income (O – yield 4.9%) – In a highly uncertain environment like this, where the narrative can change on a dime, income is king. And this legendary income REIT is the king of income stocks. It has paid 632 consecutive monthly dividends and increased the dividend payment 119 times since its IPO in the 1990s. And the REIT has been growing stronger through acquisitions of late. Earnings grew at 9.2% for 2022, which is above the historical average, and it did it in a challenging year. Despite being a retail REIT, the portfolio is largely staple properties like drug stores and supermarkets that are resilient in a slower economy. HOLD

The Williams Companies, Inc. (WMB – yield 6.0%) – WMB has been a struggling stock this year because of natural gas prices, which have crashed. Although the company is not highly levered to energy prices, it is affected by turbulence in its industry. Prices have fallen largely because of the unusually warm winter temperatures throughout the country and the world. Demand for the fuel has been far less than anticipated and stockpiles have built up. But it is a temporary problem for a fuel source that should own the next decade. And WMB has gotten cheap. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 3.7%) – This is a transition year for AbbVie as its mega-blockbuster immunology drug Humira faces a U.S. patent expiration. Sales of $20 billion at the peak in annual revenue for the drug are estimated to drop 37% this year and company revenues are expected to decline in 2023 as a result.

However, this expiration has been factored into the price for years now and ABBV sells at a very low multiple versus its peers. It also has one of the best pipelines in the business and its two newer immunology drugs (Rinvoq and Skyrizi) are expected to generate $17.5 billion in revenue in 2025 and $21 billion in 2026. It’s encouraging that the stock has been trending higher since September and indicative that the expiration is already priced in, and investors are looking ahead to a bright future. The stock is roughly even YTD and if it continues to get through this year in good shape, it should be off to the races after that. HOLD

Broadcom Inc. (AVGO – yield 2.9%) – AVGO was added to the portfolio because it is a highly resilient technology company that is mostly involved in technology infrastructure and earnings are not highly dependent on product sales. That’s why in a tough technology market AVGO has returned more than 13% YTD and recently hit a new 52-week high. The stock is still in a steep uptrend that began in October and could move a lot higher if the technology sector continues to recover. HOLD

Brookfield Infrastructure Partners (BIP – yield 4.5%) – After going nowhere since the fall, the infrastructure juggernaut is finally moving on up. It’s up over 5% in the last week and is at the highest price since last fall. Operating performance was strong all along, but the stock was under some pressure because of the strong dollar, which diminished overseas earnings, and high interest rates, as debt costs increase. But both interest rates and the dollar are moving lower. The stock is well below the 52-week high made last April but it still has very resilient earnings, a great track record, and a safe dividend. (This security generates a K-1 form at tax time). BUY

Eli Lilly and Company (LLY – yield 1.3%) – LLY was upgraded to a BUY a couple of weeks ago. After a stellar 2022 where it returned 34% in a bear market, LLY has pulled back this year. LLY is notoriously bouncy and tends to pull back after every surge. Despite the recent earnings stumble, this company still grew earnings 12.7% in 2022 and is expected to grow earnings by an average of 22% per year over the next five years. It also has two drugs that could be mega blockbusters in the pipeline that could be approved in the next year. It made sense to buy the dip and the stock is already up about 15% since being upgraded. BUY

Intel Corporation (INTC – yield 1.5%) – Things are certainly looking up for this beleaguered stock. INTC soared more than 30% in the month of March and has broken out to the highest level since last summer. Part of it is a rally off the bottom as the stock sunk to book value after lousy earnings and guidance and a dividend cut. Intel is still a powerful industry player and its recent attempts to catch up to its competitors should succeed to a least some degree over time.

But there has also been good news recently. It announced the earlier-than-expected release of its new CPU chip for data centers. Production problems had been an issue, but it looks like that is being overcome and bodes well for the many high growth chips in the works. It should also help boost earnings sooner than expected. HOLD

Qualcomm Inc. (QCOM – yield 2.4%) – This is a great longer-term stock of a company with a huge share of mobile 5G chips and strong exposure to some of the fastest growing areas in technology. Meanwhile, it sells at a very cheap valuation by historical standards. QCOM has been pushed around by the sector since it’s been under pressure but there has been new life lately. Inflation is coming down and interest rates are falling and technology is the best performing sector YTD with the group up over 20%. At some point this year, the market should start sniffing out the recovery, if one hasn’t already begun. And QCOM can make up for lost time fast when it moves. HOLD

Visa Inc. (V – yield 0.8%) – V is tied to the fortunes of the more cyclical stocks in the near term. But it tends to outperform that group. It held up nicely in a very tough 2022 with a -3.4% return for the year, it’s up over 30% since the September low, and it has a better than 10% return YTD. Of course, it could be under pressure if the economic situation deteriorates. But the stock is still relatively cheap, and it should fly when the market eventually senses the end of this cycle and the next recovery. BUY

Safe Income Tier

NextEra Energy (NEE – yield 2.4%) – This combination regulated and clean energy utility stock has struggled somewhat over the past year, down 8.5%. Almost all of that loss is YTD though. It was resilient in last year’s bear market. The truth is that defensive sectors have lagged so far this year while technology and consumer discretionary stocks have been the best. It’s likely because of a rebound or a diversion toward the mean. But NEE is still well positioned as a defensive stock with growth in a highly uncertain market. BUY

Xcel Energy (XEL – yield 3.1%) – This clean energy utility stock is also trading in a lower range since moving down in the first two months of the year, although it moved higher in March. Meanwhile, the market remains uncertain, and the economy is likely to slow. It’s a good stock to buy almost anytime. But after having gotten cheap ahead of a period of likely relative outperformance, XEL is a good place to be. BUY

USB Depository Shares (USB-PS – yield 5.3%) – This preferred stock has bounced around with interest rates since being added to the portfolio, moving lower when long-term interest rates rise and vice versa. But interest rates have plunged since the banking problems and increasing fear of recession and this stock has moved higher again. The 10-year rate seems to top out around 4% and then pull back. BUY

Invesco Preferred ETF (PGX – yield 5.8%) – Longer-term rates are bouncing around and have recently been moving lower again. It is still a good time to buy this preferred ETF and the stable income provides a cushion in tough markets. Plus, rates may come if the economy weakens. BUY

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.4%) – There could be some near-term turbulence with the price on the way to solid longer-term returns and diversification. The increased risk of a recession this year bodes well for the near-term total return of this fund. BUY