Cabot Dividend Investor Issue: March 8, 2023

2 Stocks to Profit Amid Persistent Inflation

Inflation has come down. After eight Fed rate hikes, inflation has fallen from 9.1% in June to 6.4% in January. That’s progress. But it is still a million miles from the Fed’s target rate of 2%.

The hope is that this inflation can be tamed, even if it takes a mild recession. And we can go back to the way things were. I hope that’s the case. But history indicates otherwise. In the past when inflation stayed this high for this long, it took about a decade to get rid of it. That’s why the inflation rate averaged 7.25% in the decade of the 1970s and 5.82% in the 1980s.

After moving lower in the second half of 2022, inflation ticked higher again in the first part of this year. Even if inflation does come down a lot over the course of the year, it may come right back in the next recovery. That’s what kept happening in the 1970s. This inflation fight may be far from over.

Anything is possible of course. But in the past, once that inflation genie gets out of the bottle it has historically been a long ordeal to get it back in. Higher inflation and interest rates may persist for several years to come. That’s a different economic situation than we have faced in a long time. And it is changing the investment landscape.

For the past 15 years, technology and other growth stocks that thrive with low inflation and low interest rates have thoroughly dominated in terms of market performance. That’s because inflation averaged less than 2% per year in the first two decades of this century and the Fed kept the benchmark short-term Fed Funds rate under 2% for most of the last decade.

But inflation averaged 7% in 2021 and 6.5% in 2022. The Fed has raised the Fed Funds rate from 0% - 0.25% to 4.5% - 4.75% in less than a year, the highest level in 15 years. And they’re not done. The effects of this change are already clear. Since the beginning of 2022, the iShares S&P 500 Growth ETF (IVW) has returned -25.56% while the iShares S&P 500 Value ETF (IVE) returned 0.03% over the same period.

It’s well worth considering the stocks and sectors that have historically behaved well during inflation. Value and dividend stocks, which are often the same thing, tend to outperform growth stocks and the market in flat and down markets, especially during times of inflation.

While dividends have accounted for about 40% of the total return on the S&P 500 over the last century, that contribution has been much higher during inflation. In the high-inflation decades of the 1940s and 1970s, dividends accounted for a staggering 67% and 73% of market returns respectively.

As investors, we need to invest in a way that not only keeps pace with inflation but exceeds the rate of inflation in order to actually grow a nest egg in real terms. In this issue, I highlight two portfolio dividend stocks that have a unique ability to thrive during inflation beyond most dividend stocks.

What to Do Now

January was up. Then February was down. Last week was the best week for the market in a month. This week is down so far. Do you see the pattern?

The market can’t decide which way to go. It just sort of bounces around en route to nowhere. That’s better than falling to new lows. But we are likely to see a sideways trend for the foreseeable future.

Of course, anything is possible. Stocks could muster a significant rally if inflation falls sharply, the Fed stops hiking, and we avoid a recession. Stocks could fall to new lows if inflation persists at high levels, the Fed hawkishness continues, and/or the economy falls into recession. But it is more likely that stocks trend mostly sideways with a possible up or down bias.

To truly rally out of this bear market, investors will need to see past this inflation/Fed cycle and past the economic bottom. But with a still-strong economy, over 6% inflation, and a Fed that will probably leave rates high into next year; that rally is unlikely until late this year at the earliest.

A new bottom is unlikely unless inflation is much worse than currently expected or the economy falls into a deeper recession than currently expected. But inflation should be tempered by a weaker economy for now as the eight previous Fed rate hikes filter through. The Fed can talk a hawkish game all it wants, but it is highly unlikely that they raise the Fed Funds rates above 5.25% or 5.5% at the highest. And the rate is already 4.75%.

A slowing economy or mild recession might be just what the doctor ordered. As long as the economy is strong, inflation will persist at too high a level. The Feds won’t call the dogs off and consider lowering rates until the economy turns south. At this point, economic strength seems to be prolonging the market malaise.

In a likely sideways market, income is king. Dividends keep rolling in even if stock prices don’t move higher. Also, dividend-paying stocks tend to outperform the overall market in sideways and down markets.

Most of the portfolio stocks currently rated “BUY” offer safe dividends and revenue that should remain solid even through inflation and a slowing economy. Two new stocks have been added to the “BUY” list in this issue, Eli Lilly (LLY) and Xcel Energy (XEL). Both stocks have fallen in price ahead of a period of likely market outperformance.

If you don’t own these stocks, a full position is a good idea. But the portfolio will simply add back the 1/3 positions that were sold at an earlier date, and the allocations will reflect an additional 1/3 position in each stock.

Featured Action:

Visa (V) Yield: 0.82%

Visa is a global payments technology company that provides digital currency instead of cash and checks to individuals and businesses in more than 200 countries and over 160 currencies. It is the largest payment processor in the world with systems that can process 65,000 transactions per second.

Visa doesn’t loan money. You can charge things with a Visa card instead of using a debit, but it is the sponsoring bank that loans the money, not Visa. It’s the bank’s problem if someone can’t pay. Visa simply collects a fee on any debit, credit or mobile transaction. It rings the register every time individuals and businesses all over the world make a digital transaction with its cards.

Cashing in on transactions is practically a license to print money. The dominance of this company and stock in the past is undeniable. Look at the returns for the last 5, 10, and 15-year periods for V versus the overall market (with dividends reinvested as of 3-05-2023).

But we care about the future at this point. And the future looks bright as well. The global trend toward cashless transactions is gaining traction. In fact, digital payments surpassed cash transactions on a global basis a few years ago. The trend will accelerate going forward and Visa is in the ideal position to benefit.

Despite having a commanding market share in the electronics payment industry already, there is still plenty of runway for growth as more people go cashless and the global middle class continues to expand. Visa’s size and scale should allow the company to improve its already sizable margins.

The global economy recovered from covid and travel came back in a big way, especially the very profitable cross-border transaction business. Visa grew earnings by 24% in fiscal 2022. In this year’s fiscal first quarter, Visa beat expectations with earnings per share growth of 21% as transaction volumes continued to rebound.

In 2022, while the S&P 500 returned -19.4% and the Nasdaq fell 33% for the year, V registered a total return of -3.4%. Despite financial and cyclical stocks taking the brunt of the selloff, V held its own in the bear market as pent-up travel demand and the global covid recovery more than offset any slowdown in the global economy.

The stock should hold up in inflation. Transaction amounts will reflect higher prices and Visa has a relatively low amount of debt, which should enable the company to fare relatively well with higher interest rates.

V can soar when the market eventually turns around. V is always among the first financial stocks to rally when the market moves higher. A turnaround is probably coming before the end of the year. In the first year of the recovery from the last bear market V shot up 65%. In other good years like 2017 and 2019, V returned 44% and 42% respectively.

ONEOK, Inc. (OKE) Yield: 5.8%

ONEOK is a large U.S. midstream energy company specializing in natural gas. It owns one of the nation’s premier natural gas liquids (NGLs) systems connecting NGL supply in the Rocky Mountains, midcontinent, and Permian regions in key market centers, and also has an extensive network of natural gas gathering, processing, storage and transportation assets. A whopping 10% of U.S. natural gas production uses ONEOK’s infrastructure.

Here are some things to like about the company and stock.

• Investment grade-rated debt
• 85% of earnings fee-based
• 26 years of stable and growing dividends
• C corporation structure (generate a 1099 and not a K1)

Earnings are resilient because ONEOK operates in the best segments and is well-positioned in the high-growth shale regions. Natural gas is a rapidly growing fuel source that is much cleaner burning than oil or coal. NGL is by far the fastest-growing fossil fuel source. During the pandemic, in one of the worst years ever for the energy industry, ONEOK’s NGL and dry natural gas volumes both continued to grow anyway.

OKE pays a stellar 5.8% yield. That’s not too good to be true for several reasons. The company has grown or maintained the payout for 26 straight years that include recession and terrible energy environments. It has also grown the dividend at a better than 8% average annual clip for the last five years.

Why buy it now?

OKE returned a solid 16.46% in 2022. That was about on par with the rest of the midstream energy subsector. But performance had been much better than its peers. The stock returned a stellar 68% in 2021. The lower relative performance last year was for two reasons. One, after the huge 2021 performance, it didn’t have as much ground to make up. Two, earnings didn’t grow as strongly as much of the sector last year because they never decreased very much during the pandemic.

ONEOK also has automatic inflation adjustments built into its contracts. The company doesn’t have to compete on price because, as do most midstream energy companies, it operates a near monopoly in its area. It will pass higher costs on to its customers and demand is likely to remain resilient because of the high demand for natural gas both in the U.S. and globally.

Despite higher earnings and better prospects, OKE still sells below the pre-pandemic high.

Recent Activity

March 8^th
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”

Current Allocation

Stocks 34.7%

Fixed Income 20%

Cash 45.3%

Portfolio Recap

Enterprise Product Partners (EPD – yield 7.7%) – This midstream energy partnership doesn’t seem like it’s doing much. But EPD is quietly holding its own in a back-and-forth and uncertain market this year. EPD is returning a market-beating YTD 11% return after delivering a stellar 18.4% return in the 2022 bear market. The stock also recently broke out of the recent range to the higher price levels of last summer. EPD is also well positioned for inflation, a faltering economy, or both. (This security generates a K1 form at tax time). BUY

Enterprise Product Partners (EPD)
Next ex-div date: April 28, 2023, est.

ONEOK Inc. (OKE – yield 5.8%) – This midstream energy company once again reported strong earnings that beat expectations. Earnings per share soared a whopping 28% in the fourth quarter and 15% for the full year. Earnings reflected steady growth in natural gas pipelines and gathering and continued growth in the natural gas liquids segment, despite an overall slowdown in exports. But the stock has delivered returns slightly below those of the overall market so far this year. OKE had moved sharply higher from the October low but has been moving sideways for the past six weeks. OKE has been hanging tough and consolidating in this higher range ahead of a period of likely better relative performance. BUY

ONEOK Inc. (OKE)
Next ex-div date: April 28, 2023, est.

Realty Income (O – yield 4.7%) – In a rudderless and directionless market, 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. O has been trending slowly higher since the middle of October and should continue to be an investor favorite in this tough market. HOLD

Realty Income (O)
Next ex-div date: March 30, 2023, est.

The Williams Companies, Inc. (WMB – yield 6.0%) – This midstream energy company has been a bummer this year. After outperforming its peers in the down market this fall, WMB is underperforming both the overall market and its peers YTD. Williams reported solid earnings last quarter with 21% full-year growth over 2021. The issue is that the company expects slower growth of just 3% in 2023 as the benefit of recent acquisitions draws tougher comparisons. But the dividend is rock solid with 2.37 times coverage from cash flow and future growth is likely to resume at a stronger clip in the years ahead. It also has an inflation and recession-resistant business that should help it to outperform the market through the rest of this year. BUY

Williams Companies, Inc. (WMB)
Next ex-div date: March 10, 2023

Rating change – “BUY” to “HOLD”

Medical Properties Trust, Inc. (MPW – yield 11.5%) – MPW plunged 16% in the last month after the market didn’t like its fourth-quarter earnings report. The stock has since stabilized somewhat. While the company did beat expectations on both the top and bottom lines, investors didn’t like some of the information that came out of the report.

It’s tough to say specifically what spooked investors most or if it was just the negative totality. The company typically raises the first quarter dividend, but it didn’t this time. They also indicated that higher interest rates will significantly slow the pace of acquisitions this year. And finally, they said that one of the issues with a tenant will take 12 to 18 months before MPT is made whole. The lack of growth is already reflected in the stock that sells at just 6 times cash flow. However, the rating will be reduced to HOLD until the stock can establish upward momentum from here. HOLD

Medical Properties Trust, Inc. (MPW)
Next ex-div date: March 15, 2023

AbbVie (ABBV – yield 3.8%) – ABBV moved higher in February as the overall market fell after pulling back in January when the market rallied. In the near term, ABBV is somewhat tied to the fortunes of the defensive sectors. Nevertheless, the recent strength is encouraging because this is the year its U.S. Humira patent expires, and earnings are expected to decline this year as a result.

But fear of this year has been reflected in the stock price for years. That’s why ABBV sells at an earnings multiple well below that of the overall market. As I’ve long argued, the company has newer drugs growing at a huge clip that can fill the void before long, and the stock should be a big winner longer term. If results are better than expected this year and investors start to see beyond this highly anticipated patent expiration year, ABBV could get a big move higher. HOLD

AbbVie Inc. (ABBV)
Next ex-div date: April 13, 2023

Broadcom Inc. (AVGO – yield 3.1%) – What technology slump? AVGO has spiked to within 2% of the all-time high despite the sector troubles. The stock is still in a steep uptrend and has rallied over 50% from the October lows. It’s also up 9.5% in the past two weeks, buoyed by another killer earnings quarter.

The semiconductor and software giant reported 16% higher revenues and 20% earnings growth from last year’s quarter. While other companies are struggling with lower smartphone and PC sales, Broadcom continues to benefit from its emphasis on technology infrastructure. Continuing strong networking cloud spending kept profits rolling and powerful growth AI excited investors about the future. Broadcom also guided higher for next quarter. Hopefully, the stock can run to new highs from here. HOLD

Broadcom Inc. (AVGO)
Next ex-div date: March 21, 2023

Brookfield Infrastructure Partners (BIP – yield 4.6%) – The infrastructure juggernaut has been very bouncy over the last two years. It was hit along with everything else by covid as its transportation assets suffered. Lately, it has been hurt by the strong dollar and higher interest rates as the company does a lot of business overseas and has a relatively high credit balance. But it still has very resilient earnings, a great track record, and a safe dividend. (This security generates a K1 form at tax time). BUY

Brookfield Infrastructure Partners (BIP)
Next ex-div date: May 28, 2023, est.

Rating change – “HOLD” to “BUY”

Eli Lilly and Company (LLY – yield 1.4%) – After a stellar 2022 where it returned 34% in a bear market, LLY is having a tough time this year and is down 13% YTD and over 16% from the high. There are some reasons for the declining performance. Earnings disappointed, and Lilly failed to get fast-track approval for its Alzheimer’s drug because the recent study was incomplete.

But this stock is notoriously bouncy and tends to pull back after every surge. Despite the recent earnings stumble, this company is expected to grow earnings by an average of 19% 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. This pullback is an opportunity to pick up a stock that has returned 630% over the last ten years and 351% over the past five at a time when the business looks more promising than it did back then. LLY is upgraded to a BUY rating on the price decline.

It’s worth taking a full positing in the stock if you don’t own it already. This portfolio already had a 2/3 position and profits were taken on 1/3 earlier. The portfolio will simply add back the 1/3 and the stock allocation will reflect that addition. BUY

Eli Lilly and Company (LLY)
Next ex-div date: February 14, 2023

Intel Corporation (INTC – yield 2.0%) – This beleaguered stock has stayed relatively steady since announcing the 66% dividend cut. That implies that perhaps the stock has already bottomed out and the most likely future trend for the stock price is higher. The price is so low already there wasn’t much left to punish. Intel is still a powerful industry player and its recent attempts to catch up to its competitors should succeed to at least some degree over time. Meanwhile, the stock sells at a fire-sale price at just about book value. The portfolio will hold on for now. HOLD

Intel Corporation (INTC)
Next ex-div date: May 4, 2023

Qualcomm Inc. (QCOM – yield 2.4%) – A stellar January was followed by a lousy February. QCOM soared about 29% in January and the price reached the highest level since the summer. But the stock pulled back about 8% in February. QCOM is tied to the fortunes of the market and the tech sector in the near term. And the sector weakened after a strong start to the year as inflation appears to be hanging around. At some point this year, the market should start sniffing out the recovery. And QCOM can make up for lost time fast when it moves. HOLD

Qualcomm Inc. (QCOM)
Next ex-div date: June 1, 2023, est.

Rating change “HOLD” to “BUY”

Visa Inc. (V – yield 0.8%) – The payments processing company stock has been thriving. After an impressive -3.4% return in last year’s bear market, V delivered strong returns in the earlier part of the year. It pulled back somewhat in February but now appears to be moving back toward the recent high. Even if the recent cyclical rally ends, V should continue to hold up relatively well and showed a preview of how well it will react when the market finally turns for good.

The company has a strong and reliable business that continues to grow despite a slower global economy as travel and international business thrives with the end of covid restrictions. It also has unique features that enable it to endure inflation. It has continued to look strong even after the cyclical rally faded and should perform well in the year ahead. The rating is raised to BUY. BUY

Visa Inc. (V)
Next ex-div date: May 9, 2023, est.

NextEra Energy (NEE – yield 2.5%) – This combination regulated and clean energy utility had been hanging tough in the January rally as other defensive stocks lagged. But the resilient behavior ended and NEE fell 14% in the last six weeks. Earnings were stellar and there doesn’t appear to be a company-specific reason for the recent selling. It appears that the market just made up for lost time quickly. The stock is near the low point of the recent range ahead of a period where defensive stocks could thrive. BUY

NextEra Energy Inc. (NEE)
Next ex-div date: May 23, 2023, est.

Rating change “HOLD” to “BUY”

Xcel Energy (XEL – yield 2.8%) – This clean energy utility stock spiked late last year but has fallen back again. XEL is down over 8% YTD and it’s trading near the low point of the recent range. Meanwhile, inflation is lasting, and the Fed is remaining hawkish, the same scenario that enabled XEL to strongly outperform the market last year. It’s a good stock to buy almost anytime. But after having gotten cheap ahead of a period of likely relative outperformance, it is being upgraded to a BUY. BUY

Xcel Energy Inc. (XEL)
Next ed-div date: March 14, 2023

USB Depository Shares (USB-PS – yield 5.5%) – This preferred stock was added to the portfolio when interest rates were near the high, so it has returned more than 10% since. But interest rates have been moving back higher as economic strength and a hawkish Fed weigh on the fixed-income market. But rates are still high relative to where they are likely to be longer term. BUY

U.S. Bancorp Depository Shares (USB-PS)
Next ex-div date: April 15, 2023, est.

Invesco Preferred ETF (PGX – yield 5.6%) – Ditto what I said about USB-PS. Longer-term rates have moved back up to the highest level since November. It’s still unclear if they will continue to move higher or this is just a temporary bounce. But it is still a good time to buy this preferred ETF and the stable income provides a cushion in tough markets and rates may come down again. BUY

Invesco Preferred ETF (PGX)
Next ex-div date: March 24, 2023, est.

Vanguard Long-Term Corp. Bd. Index Fd. (VCLT – yield 4.1%) – There could be some near-term turbulence with the price on the way to solid longer-term returns and diversification. An imminent recession is out the window and there may be a period of rising rates again before the economy stalls out later in the year. BUY

Vanguard Long-Term Corp. Bd. Index Fd. (VCLT)
Next ex-div date: April 1, 2023, est.

Dividend Calendar

Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Dividend Investor for an explanation of how dates are estimated.

The next Cabot Dividend Investor issue will be published on April 12, 2023.