Cabot Dividend Investor Issue: November 9, 2022

Time to Lock in High Yields

We’re standing at the precipice of change. Inflation and interest rates are soaring, for now. But the embarrassed and well-behind-the-curve Fed is hell-bent on driving this economy into recession to remedy the problem they helped create.

The Fed has raised the Fed Funds rate six times this year to combat inflation and the last four times at a 0.75% clip. The current 4% rate is the highest in well over a decade. In addition, GDP contracted in the first two quarters, and it has been a bear market all year. But all that has been insufficient to even budge inflation. It will take more pain to get that inflation genie back in the bottle.

At the November meeting, the Fed Chairmen stated that the previous 4.5% to 5.0% Fed Funds goal no longer applies. It will have to go higher. How much higher? He didn’t say. He only alluded that it will have to rise sufficiently to tame this inflation, which six rate hikes, a contracting economy, and a bear market has yet to even slow.

The U.S. economy is resilient. GDP managed to grow over 2% in the second quarter, employment remains strong, and earnings have been better than feared. But the economy will eventually give way to the forces aligned against it. It is almost a certainty that there will be a recession in 2023.

Meanwhile, for the first time since forever, you can get investment-grade, fixed-rate investments that pay 5% or even 6%. But the economy is almost certainly headed towards a recession. Recessions put downward pressure on longer interest rates as loan demand dries up.

Sure, interest rates could still go higher from here. And the principle may decline on an unrealized basis in the near term. But fixed-rate securities tend to be longer-term investments. And it is far less likely that interest rates remain this elevated over the next five years. In the meantime, there is a rare opportunity to lock in a high fixed rate and add that balance to the portfolio. Let’s not miss it.

What to Do Now

The late summer selloff that drove the market to new lows didn’t account for recession. It focused instead on the current rising interest rates and inflation, which the inevitable recession should subdue. Meanwhile, some of the very best recession stocks were crushed.

As interest rates spike to the highest level since 2007, conservative dividend stocks took a beating. Higher rates mean that fixed-rate investments become more competitive and dividend stocks pay the price. But, as I mentioned above, a recession pressures interest rates lower and some of the most defensive stocks fell near the 52-week lows.

The best recession stocks got dirt cheap ahead of an inevitable recession. While the market indexes probably haven’t bottomed yet, interest-rate-sensitive stocks may well have. It’s premature to invest for recovery overall, but the recovery may have begun in certain utility stocks.

Over the past month, the utility stocks in the portfolio including NextEra Energy (NEE), Excel Energy (XEL), and Brookfield Infrastructure Partners (BIP) were upgraded from “HOLD” to “BUY.” There’s probably no bad time to buy these stocks. But near the 52-week low ahead of a time when relative performance thrives is a conspicuously good time.

It’s also a good time to buy the midstream energy stocks; Enterprise Product Partners (EPD), ONEOK (OKE), and The Williams Companies (WMB). These stocks also got hammered during the recent selloff but have been recovering strongly since. They all pay huge dividends, sell at cheap valuations, and have recession- and inflation-resistant businesses.

There will also be a time to buy the other portfolio stocks. But not yet. While the selling may not be over, they have the propensity to rise a lot over the longer term.

Monthly Recap

October 12th
Medical Properties Trust, Inc. (MPW) – SELL 1/2Broadcom Inc. (AVGO) – Rating change “BUY” to “HOLD”Qualcomm Inc. (QCOM) – Rating change “BUY” to “HOLD”Buy U.S. Bancorp 4.5% Depository Shares Non-Cumulative Perpetual Preferred Stock (NYSE: USB-PS)

October 19^th
NextEra Energy (NEE) – Rating change “HOLD” to “BUY”Excel Energy (XEL) – Rating change “HOLD” to “BUY”

October 26^th
Brookfield Infrastructure Partners (BIP) – Rating change “HOLD” to “BUY”

November 9^th
Buy Invesco Preferred ETF (PGX)

Featured Action: Buy Invesco Preferred ETF (PGX)

Yield 6.2%

This preferred stock ETF is similar to last month’s preferred stock recommendation, USB Depository Shares (USB-PS), and I like it for similar reasons. Interest rates are at the highest level since 2007 and are likely to be pressured downwards in the looming recession.

Bonds and other fixed-rate securities add balance and reduce risk in a portfolio while providing a dependable income. In markets like this, investors that own fixed securities in a portfolio tend to see their investment portfolios fall less in value and are more likely to stay invested ahead of the next bull market.

But the fixed-rate element has been sorely lacking in recent years. Bonds were low paying and treacherous with interest rates near an all-time low after a forty-year bull market in bonds. You got practically no interest while taking on significant risk if interest rates rose. Indeed, that turned out to be the case. This has been one of the worst years for bonds ever. Many bonds have lost 20% or even 30% of value as interest rates spiked higher.

But the recent spike in interest rates and decline in the price of fixed-rate securities creates a rare opportunity ahead of an almost certain recession in 2023.

The PGX portfolio is based on The BofA Merrill Lynch Core Plus Fixed Rate Preferred Securities Index which tracks the performance of fixed-rate U.S. dollar-denominated preferred securities issued in the U.S. domestic market. The portfolio currently consists of 295 different issues.

A fund like this has several advantages over an individual issue. With so many different securities, you diversify away from the risk associated with any one company or issue. There is also no risk that the fund, like an individual issue, can be called away. But perhaps the biggest benefit is that it pays dividends every single month and can make a great addition to your investment cash flow.

The fund invests in preferred securities almost exclusively in the U.S. (95.62%). Issues are overwhelmingly rated investment grade with the following percentages: A (4.04%), BBB (75.97%), BB (17.65%). The rest are rated B, not rated, or in cash. All the securities have a maturity greater than five years from now.

The holdings comprise mostly banks. Top holdings include Citigroup, JPMorgan Chase, Wells Fargo, Bank of America, and AT&T.

PGX is a great way to lock in high monthly income and add balance to your portfolio ahead of a likely recession.

Invesco Preferred ETF (NYSE: PGX)
Security type: exchange-traded fund (ETF)
Industry: preferred stock
Price: $11.10
52-week range: $11.01 – $15.19
Yield: 6.2%
Profile: The fund is comprised of U.S. dollar-denominated fixed preferred securities.

Positives

• The yield is at the highest level in over a decade.
• Recessions tend to drive these rates lower.
• Preferred stock has low correlation to other investments and helps diversify a portfolio.

Risks

• Preferred stocks, like bonds, will lose value if rates continue to rise.
• Even if rates fall, they could rise again in the next recovery.
• It’s possible that a recession is avoided and rates continue higher.

Invesco Preferred ETF (PGX)
Next ex-div date: November 19, 2022, est.

Portfolio at a Glance

Enterprise Product Partners (EPD – yield 7.6%) – The midstream energy partnership reported strong earnings. Cash flow from operation was up 13.2% and distributable cash flow rose 16% for distribution coverage of a sensational 1.8 times. Enterprise also reported record volumes of throughput of oil and gas, the main driver of profits. But the market yawned. EPD is still well off the high of June. It seems to have gotten somewhat caught up in a more inclusive market malaise. But with decent price performance and that amazing distribution yield, EPD is a huge winner in this environment. I expect the same or better going forward. (This security generates a K1 form at tax time). BUY

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

Medical Properties Trust, Inc. (MPW – yield 10.3%) – Earnings continue to be solid for this unloved and neglected hospital property REIT. Earnings grew at about 30% for the quarter and the stock has risen about 12% over the past month. Results strongly indicate that the stratospheric dividend should be safe. The stock had been beaten to a pulp with shares down about 50% YTD. It’s been an unforgiving market where negative sentiment stays entrenched. But fundamentals should win in the end. HOLD

Medical Properties Trust, Inc. (MPW)
Next ex-div date: December 14, 2022, est.

ONEOK Inc. (OKE – yield 6.2%) – ONEOK reported earnings that beat estimates for the third quarter and expected a more than 10% increase in net income for 2023. Demand and volumes for natural gas continue to be resilient and are expected to remain so as demand in Europe and Asia remains huge. The stock has been trending consistently higher since the low of late September. Earnings rose even during the pandemic and this company should be solid in a recession. Plus, ONEOK has automatic inflation adjustments built into its contracts. The high dividend and resilient business should make OKE a strong holding going forward. BUY

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

Realty Income (O – yield 4.7%) – Earnings for this legendary income REIT surpassed estimates as it declared its 100^th consecutive quarterly dividend increase. Revenue soared 80% as results continue to reflect the merger with VEREIT that was completed a year ago. Normalized funds from operations per share rose 9% compared to last year’s third quarter and 7.7% from the last quarter. Realty’s typical tenants of drug stores, convenience stores and supermarkets enabled it to continue raising the dividend through the pandemic and should prove resilient in this recession. BUY

Realty Income (O)
Next ex-div date: November 30, 2022, est.

The Williams Companies, Inc. (WMB – yield 5.1%) – This midstream energy company has quietly been on fire. It’s up over 40% from the low of late September and not that far from the 52-week high. Williams reported earnings that topped estimates with earnings growth of 15% over last year’s quarter. A big reason for the strong earnings is resilient natural gas demand, something that is likely to endure through the recession based on shortages overseas. The stock is getting a bump and the good times should continue. BUY

Williams Companies, Inc. (WMB)
Next ex-div date: December 8, 2022

AbbVie (ABBV – yield 4.1%) – Healthcare is a great place to be right now as a recession looms in the near future. People get sick and take medicine regardless of the economy, and the sector is among the best to own when the economy goes south. And ABBV consistently significantly outperforms the sector. ABBV has a positive return YTD, which makes it somewhat of a superstar in this crummy market. Of course, ABBV is still way off the high of last spring. It is probably Humira concerns due to the U.S. patent expiration next year. But I believe those fears are well overblown. HOLD

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

Broadcom Inc. (AVGO – yield 3.5%) – While the chipmaker and infrastructure software provider continues to deliver on an operational basis, it’s getting creamed by this market. Broadcom doesn’t report earnings until next month, but it has typically been stellar in past reports. Last quarter it delivered 40% earnings growth and a 25% revenue increase and raised guidance for the rest of the year. But that seems to matter very little in a year when the whole technology sector continues to get crushed. Things may get worse before they get better for the stock, but AVGO should have significant upside longer term. HOLD

Broadcom Inc. (AVGO)
Next ex-div date: December 21, 2022, est.

Brookfield Infrastructure Partners (BIP – yield 4.0%) – The infrastructure partnership reported terrific earnings last week. It soundly beat expectations with funds from operations (FFOs) growth of 24% for the quarter. That’s impressive considering BIP has fallen more than 20% from the high over the past couple of months. Rising interest rates soured investors as fixed-rate alternatives became more attractive. But the selling is likely overdone because its crucial assets will continue to deliver steady earnings through a recession, it has inflation adjustments built into its contracts, the dividend is solid, and the stock is cheap now. BUY

Brookfield Infrastructure Partners (BIP)
Next ex-div date: November 29, 2022

Eli Lilly and Company (LLY – yield 1.1%) – What bear market? LLY just hit a new all-time high. Healthcare is a great place to be in a slowing economy and LLY is the best of the best. It beat expectations on earnings last week but lowered yearly guidance. The market was a little disappointed for a day or so but then LLY started rising again because the main story is the pipeline. It has two potential mega-blockbusters pending approval.

Its diabetes drug Mounjaro is pending fast-track approval for weight loss. Studies so far have made the drug one of the most promising ever seen in a country where nearly 2 in 5 adults are considered obese. Some analyst estimates the drug could have annual sales of $25 billion. There’s also the Alzheimer’s drug that could be huge. HOLD

Eli Lilly and Company (LLY)
Next ex-div date: November 14, 2022

Intel Corporation (INTC – yield 5.1%) – This stock may well have bottomed. Earnings were terrible again but that’s probably already baked into the stock. The near term is ugly, but the dividend is safe, and the future could be very bright. INTC currently sells near book value. It also has significant promise in its growing foundry business that should be further aided by government subsidies. The company isn’t at risk of bankruptcy and the dividend is significant with a low payout ratio. Hopefully, the bottom is in on a stock that should perform well over the long term. HOLD

Intel Corporation (INTC)
Next ex-div date: November 4, 2022

Qualcomm Inc. (QCOM – yield 2.8%) – Qualcomm delivered earnings last week that disappointed the market. The current quarter met expectations with 22% revenue growth and 23% earnings growth but reduced expectations for next year sunk the stock about 8% on the day of the report. QCOM fell to a new 52-week low but has since been recovering.

The main issue is that smartphone sales are falling as it gets later in the upgrade cycle and the economy deteriorates. Analysts now expect just 5% revenue growth and 2% earnings growth in 2023. It’s taking the brunt of the cyclical nature of the business. But slowing phone sales have already been anticipated and hitting the stock all year. QCOM now sells at just nine times forward earnings. Things stink now but the stock is also setting up for massive returns when the cycle turns. HOLD

Qualcomm Inc. (QCOM)
Next ex-div date: November 30, 2022

Visa Inc. (V – yield 0.9%) – Visa reported earnings last week that once again killed it. Revenue spiked 22% and earnings were up 27% from last year’s quarter. The payments processing giant continues to benefit from the end of covid restrictions despite the slower economy. V got a nice bump after earnings. But the situation is murkier going forward as the U.S. and global economies continue to deteriorate and the dollar continues to rise in value. HOLD

Visa Inc. (V)
Next ex-div date: November 9, 2022

NextEra Energy (NEE – yield 2.2%) – The alternative energy utility continues to rebound since being upgraded to a BUY. This is one of the best utilities on the market with reliable revenues in any economy and growth from its huge clean energy business. The stock was decimated in the recent selloff because of spiking interest rates. But the evolving recession is likely to knock rates down in the months ahead. And NEE should be a stellar relative performer in a recession. Also, management is anticipating that subsidies and incentives from the recently passed Inflation Reduction Act will be significant. BUY

NextEra Inc. (NEE)
Next ex-div date: November 23, 2022

U.S. Bancorp Depository Shares (USB-PS – yield 6.1%) – Interest rates have spiked to the highest level in more than a decade. This investment-grade, fixed-rate investment is something that income investors have missed for many years, a sizable yield on a safe income investment that is diversified from the stock market. Interest rates may go higher. But they are less likely to average higher over the next several years as a recession will put negative pressure on rates. BUY

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

Xcel Energy (XEL – yield 3.0%) – Xcel reported a slight miss in earnings last week. But the stock has been trending higher anyway because it was oversold in the September market plunge. XEL is up 16% since the low in mid-October. This stock does tend to bounce around a lot on a longer-term upward trend. It should also benefit from new legislation from Washington that will reduce costs on its considerable clean energy production. The stock should be solid in a recession. BUY

Xcel Energy Inc. (XEL)
Next ex-div date: December 14, 2022, est.

Interest Rate Clarification

It’s a good time to add clarity about interest rates to avoid possible confusion. I keep talking about the Fed raising rates higher and higher. Then, at other times, I make the point that a recession is likely to drive interest rates lower. What gives? Are they going up or down?

The rate that the Fed is currently raising is called the Fed Funds rate. That is the interest rate banks charge each other to borrow and lend excess reserves overnight. It has a strong influence over short-term rates charged on consumer loans and credit cards and is considered the benchmark for short-term rates in the country. The Fed has direct control over this rate.

But that is different from longer-term rates. The 10-year Treasury rate is considered a benchmark for these. Longer-term rates apply to mortgages and most loans and bonds. The Fed has far less control over these rates and the market is the primary determinant. The short- and longer-term rates can move in different directions. In fact, during recessions, they often do.

For example, the inflation rate may be around 8% for now. But the market may not want to factor inflation that high for 10 years or longer. Also, the longer rates are driven by demand, which tends to decrease during a recession as demand for loans dries up. Typically, longer-term rates fall during a recession. And that may be the case this time even if the Fed leaves the Fed Funds rate at a high level.

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 December 14, 2022.