February 21, 2024

Sticky Inflation and High Interest Rates

The market has had a good year so far. The rally that began at the end of October is still in force. But things are getting wobbly.

Last week’s inflation number came in higher than expected. CPI was 3.1% for January and that’s down a lot from the high of 9.1% in June of 2022. But it’s still above the Fed’s target rate of 2%. And inflation has stopped going down even with interest rates at the highest level in decades. That’s a problem.

The sticky inflation makes Fed rates cuts less likely anytime soon. In the past, inflation has been sticky and reignited after the Fed took its foot of the gas. The Fed knows this and will be reluctant to cut the Fed Funds rate, at least in any impactful way, and risk triggering decade-long inflation that is at least partially of their own making.

The current high rates will drive the economy down eventually. Already strapped consumers will have to pay much higher interest while prices on average are already more than 18% higher than they were three years ago. Companies will have to roll over debt at much higher rates. At some point in the near future, the Fed will need to lower interest rates in order to keep the recovery alive. But they can’t.

Sure, they can make a 0.25% cut here and there. But that is unlikely to bolster the economy or satisfy investors. It looks like rates will stay high until they drive down the economy. The market may have to deal with high rates until it must deal with recession. Either scenario can be negative. The Goldilocks scenario of falling inflation and a still-strong economy probably won’t last.

The market could soon face a tug-of-war between inflation and recession. That said, there is still the huge benefit of the artificial intelligence catalyst. And defense stocks are cheap. But it isn’t prudent to chase stocks that benefit most from the current environment because change is coming.

The portfolio remains diversified as the current dynamic unfolds.

Recent Activity

February 7
Visa Inc. (V) – Rating change “BUY” to “HOLD”

February 14
AbbVie Inc. (ABBV) – Rating change “HOLD” to “BUY”

High Yield Tier

Brookfield Infrastructure Partners (BIP – yield 5.1%) – The infrastructure partnership isn’t doing much of late. But that’s good. Most defensive dividend stocks are taking it on the chin again this year. But BIP has just gone sideways YTD. Eventually, the interest rate trade will go Brookfield’s way. In the meantime, the company is producing solid results. Profits are in line with what the company expected and the distribution was raised by 6% as planned. The last two years were crummy for defensive income stocks, but this year should be a lot better and BIP is one of the best. (This security generates a K-1 form at tax time.) BUY

Enterprise Product Partners (EPD – yield 7.4%) – The midstream energy partnership is back up near the 52-week high after a solid earnings report. The company should deliver solid growth this year with anticipated steady hydrocarbons demand and $3.5 billion in recent growth acquisitions coming online. EPD has produced solid and steady returns in different market environments with a 17.45% return in 2023 after a strong bear market return of 15% for 2022. It should deliver another solid year in 2024. (This security generates a K-1 form at tax time). BUY

ONEOK Inc. (OKE – yield 5.5%) – Midstream energy companies are moving higher this month and OKE, as a more volatile stock, is benefiting more than its peers. The stock is up 12% in the last couple of weeks and came within a penny of the 52-week high. But OKE is still priced below the pre-pandemic high despite having higher earnings now. ONEOK will report earnings next week that could give the stock a further lift. The company raised the guidance on projected consolidated earnings last quarter. BUY

Realty Income (O – yield 5.9%) – This is a legendary monthly income stock that has historically been a fantastic holding for income investors. It had a lousy two years as interest rates rose. But it soared at the end of last year after interest rates peaked. And O has had a crummy start to this year as the interest rate trade has reversed, for now. It is still a great stock at a cheap price. Receding inflation and likely peak interest rates remove the main downside catalyst that has been in place for the past two years. The REIT reports earnings this week. BUY

The Williams Companies, Inc. (WMB – yield 5.5%) – The year started awfully for dividend stocks and the energy sector is barely positive YTD. That’s an ugly backdrop for WMB. It fell near the lowest level since last fall. But the defensive and high-end midstream energy stock has been moving higher again of late as earnings beat expectations and the company raised guidance for 2024. While the market environment temporarily turned against WMB, it is still kicking butt and taking names operationally. It pays a well-supported dividend (with 2.38 times cash flow coverage). Recent acquisitions and expansions ensure more solid growth going forward all the way out to 2028. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 3.5%) – ABBV is coming off a very crummy year in 2023. It returned just -0.70% for the year while the overall market had a good year. The company had to deal with shrinking revenues and earnings as its mega-blockbuster drug Humira lost patent exclusivity in the U.S. But that has been long expected and well-planned for. Investors are now looking toward the promising future as management expects moderate earnings growth this year and robust growth next year. AbbVie appears closer to turning the corner than analysts expected. The stock is up nearly 30% since late November and just made a new all-time high. BUY

American Tower Corporation (AMT – yield 3.6%) – The short-term timing of this stock purchase is looking bad so far. It trades like a volatile REIT, which has been a bad thing lately. The current situation in the market could completely reverse in a matter of months or even less. This is one of the best REITs on the market that deals in very high-quality properties. The cell tower properties will only grow in demand in the years ahead and in any other interest rate environment AMT will sell at a much higher price. AMT will most certainly shine again. In the meantime, it pays you to wait. BUY

Broadcom Inc. (AVGO – yield 1.7%) – This artificial intelligence winner keeps on going. The stock price has more than doubled since certain AI stocks turned into sex symbols after the Nvidia (NVDA) earnings report last spring. AVGO tends to surge higher, then bounce around sideways for a while until the next surge higher. Even after fantastic returns in 2023, AVGO is up 10% YTD and more than 30% since early December. AI provides certain technology companies with a huge growth catalyst that should last for years. Broadcom doesn’t report earnings until March 7. Anticipation is lifting the stock still higher. Hopefully, the party will continue. HOLD

Digital Realty Trust, Inc. (DLR – yield 3.6%) Earnings – The data center REIT reported earnings last week that missed expectations and the stock is down 10% since the day of the report. Revenues grew 11% from last year’s quarter, but core funds from operations (FFOs) came down 1.2% for the same period. The main issue is that the company is investing heavily to take advantage of the expanding AI market. That’s a good thing but it hampers profits near term. DLR had been up over 50% since November and any level of disappointment was liable to push the stock down. The same positive catalysts are in effect for this year and beyond and now the stock is cheaper. BUY

Eli Lilly and Company (LLY – yield 0.7%) – Lilly again killed on earnings and guided higher for 2024. LLY, like AVGO, surges higher and then levels off for a brief period before the next surge higher. The big pharma superstar crushed expectations on earnings. It’s highly watched, newly approved weight loss drug Zepbound more than doubled sales expectations for the quarter. The mega-blockbuster potential is enormous, and Lilly just opened a $2.5 billion plant in Germany to crank up production to meet soaring demand. The company also has an important Alzheimer’s drug awaiting FDA approval in the next few months. LLY is already up 32% YTD and has returned over 400% since being added to the portfolio. It never seems to stop trending higher. HOLD

Intel Corporation (INTC – yield 1.1%) – The red-hot chip maker finally cooled off after earnings guidance disappointed and the stock fell from the recent high. But it has since leveled off and the selling may be over for now. The bounty from the new chips and the foundry business might not come as soon as optimistic investors had been hoping. The future is still bright. There are great days ahead. But the recent spate of good news had investors hungry for more. They didn’t get it from the earnings report. But headline risk favors the upside for this stock in the months ahead. BUY

Marathon Petroleum Corporation (MPC – yield 1.9%) – You never know. When MPC was purchased in the portfolio, I believed the economy would turn south in the months ahead. But I wanted a hedge in case I was wrong. That’s turning out very well so far. The economy is stronger than expected and this refiner stock is shining near all-time highs. Earnings and revenues remain very strong by historical standards. The company is flush with cash from the boom times while robust profits continue to roll in. MPC is also poised to rise on continuing tension in the Middle East, which tends to lift all energy stocks. BUY

McKesson Corporation (MCK – yield 0.5%) – This supply chain pharmaceutical goliath reminded investors why it is such a great stock. It soundly beat earnings expectations last week with 15% revenue growth and 12% earnings growth over last year’s fourth quarter. McKesson also raised guidance for 2024. Results were driven by 18% higher prescription pharmaceutical volumes mainly because it dominates a market that grows all by itself because of the aging population. MCK pulled back after the report but still remains in a strong uptrend that began last spring. It should continue to be a solid stock regardless of what interest rates or the economy do. BUY

Qualcomm Inc. (QCOM – yield 2.1%) – After a strong start to this year, QCOM pulled back after a solid earnings report. The pullback was more about the absence of exciting news rather than bad news. But the stock has since rebounded sharply and is up 45% since late October. It should be a good year. The Semiconductor Industry Association is forecasting 13% growth in worldwide chip sales this year. Leaders like Qualcomm should experience a much higher level of growth than the overall industry. Qualcomm is introducing new AI chips for PCs and smartphones that could be big sellers this year. BUY

UnitedHealth Group Inc. (UNH – yield 1.4%) – This is a great healthcare stock that has gone nowhere in the last two years. It’s still down slightly YTD as Wall Street didn’t like its fourth-quarter earnings report. The company reported double-digit earnings and revenue growth, but costs were higher than expected. But the company doesn’t expect costs to have a negative impact on 2024 projections. UNH is always up on bad days in the market where practically everything else is down. It offers a good long-term trajectory plus downside insurance. BUY

Visa Inc. (V – yield 0.8%) – Visa is thriving in the current environment. The economy is still strong and consumers, which showed signs of weakening late last year, are bounding with optimism again. That’s why V has spent this year making a series of new all-time highs. Earnings last month beat estimates with upbeat guidance through 2024. As long as the environment remains positive with a resilient consumer, V could continue to run higher from here. But the stock has moved above the ideal buy range. HOLD

Safe Income Tier

Alexandria Real Estate Equities, Inc. (ARE – yield 4.3%) – The short-term timing of this stock purchase is bad so far. This is a phenomenal life science property REIT. It was a superstar as REITs rallied in the last two months of last year but has been a dog so far in 2024 as the interest rate trade reversed amid the better-than-expected economy. But things change.

Alexandria has a unique and growing property portfolio, but it trades like a volatile REIT, which has been a bad thing lately. The current situation in the market could completely reverse course. Meanwhile, this is one of the very best REITs on the market still selling at an absurdly cheap valuation. Anomalies never last that long in the market. Holding ARE will prove to be very worthwhile before long. BUY

NextEra Energy (NEE – yield 3.6%) – NEE had been a superstar performer before inflation and rising interest rates. It provides both safety from its best-in-class regulated utility business and growth from its considerable clean energy business. The utility reported strong earnings that exceeded expectations again last month and reiterated its growth projections for this year, near the top of the estimated range. The interest rate-related weakness should at least diminish going forward as rates have likely peaked. This stock is still oversold. It should have its day in the sun again, and probably before long. BUY

USB Depository Shares (USB-PS – yield 5.6%) – The party isn’t over for fixed income. Rates have still peaked and may well trend lower for the year. The price has soared from the low of late October and has provided a double digit total return since being added to the portfolio in October of 2022. After the worst two years ever for fixed income, this preferred issue is well positioned for a further rebound. BUY

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.7%) – Ditto for VCLT, as evidenced by the recent 20% price surge. This long-term bond fund is very sensitive to interest rates. It held up relatively well in the rising rate environment and now rates may continue to trend lower. If the economic strength lasts, VCLT should remain stable and deliver a strong income. If the economy weakens, and/or rates move lower, there should be more upside for the price. BUY

Xcel Energy (XEL – yield 3.5%) – Utilities are still remarkably reliable revenue generators in any economy. Alternative energy is still the wave of the future. A combination of safety and growth is still highly desirable. But XEL has been a dog. It had a rotten two years until November and December when it turned sharply higher. But January saw a return of ugliness as investors walked away from interest rate-sensitive stocks. But Xcel reported solid earnings on lower operating expenses. This is one of the best utility stocks to own and the recent debauchery may prove to be very temporary. BUY

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