February 28, 2024

A Different Market is Coming

All is well with the market so far this year. The S&P is up 6.7% in less than two months. It’s a continuation of the 23% rally that started at the end of October and a more than 40% rise from the bear market low in late 2022.

But recent news may jeopardize the current market dynamic. January CPI was higher than expected and indicated that the current problematic inflation isn’t dead yet. Sure, it’s way down from the 9.1% peak in mid-2022 to 3.1%, but it has been rising for several months and is still well above the Fed’s 2% target.

If inflation isn’t dead, it can come roaring back as it has in past bouts of problematic inflation. If the Fed takes its foot off the gas and cuts rates, at least to any impactful degree, it could reignite the problem. It could then take another painful rate hiking cycle just to get back to where we are now. The Fed knows this and will probably be much more reluctant to cut rates than the market currently expects.

But the “soft landing” scenario expectation that has rallied this market always included falling interest rates this year. Rates will have to come down soon to preserve this recovery. But interest rates are unlikely to come down unless inflation does. And inflation might not budge unless the economy tanks. The recent Goldilocks scenario is likely to give way to either continued high interest rates or an economy bounding toward recession.

Either way, things are likely to change before long. This rally may last longer, but it’s on borrowed time. That said, the market still has a couple things going for it. The artificial intelligence catalyst is likely to continue to rally the technology sector and defensive stocks are cheap ahead of a period of likely market outperformance.

But the circumstances behind the rally since October are unlikely to last. This environment will change. For that reason, I am not chasing stocks that have been working so far this year and am instead trying to position ahead of a new dynamic that is likely coming.

Change creates opportunity. There are many great income stocks that are not benefiting in this rally. Yet these stocks are selling at historically very cheap valuations with high yields. These stocks also can thrive in a slowing economy.

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 5.6%) – It’s been an uncharacteristically bad two years for this infrastructure partnership. The inflationary and rising interest rate environment beat up the utility sector and BIP wasn’t spared. But it is unlikely that rates will continue to move higher. Meanwhile. BIP has some of the most defensive revenues possible. It’s also been expanding into cell towers, data centers and foundries as it is estimated the world needs to invest $1 trillion in digital infrastructure in the next decade. Despite the lousy stock performance, Brookfield continues to deliver strong results. Funds from operations grew 10% for 2023. This stock had blown away S&P returns for every measurable period prior to the past two years. It will rise again. (This security generates a K-1 form at tax time). BUY

Enterprise Product Partners (EPD – yield 7.2%) – The midstream energy partnership is within pennies of 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. That massive distribution is extremely well supported, and the stock is still well below the all-time high despite much higher earnings. It should deliver another solid year in 2024. (This security generates a K-1 form at tax time). BUY

ONEOK Inc. (OKE – yield 5.4%) Earnings – The midstream energy company had been making new 52-highs for the past week. Then it blew out earnings on Tuesday morning. ONEOK reported 42% increase in profits over last year’s quarter on higher LNG volumes and the contributions of the recent Magellan Midstream acquisition. The company also set ambitious guidance for this year with an expectation of increasing volumes in all areas of the business. OKE opened up more than 3% on Tuesday. It’s a great environment for midstream companies that should thrive in just about any environment. ONEOK is one of the best. BUY

Realty Income (O – yield 5.8%) – This beleaguered stock has consistently and historically been one of the very best income stocks to own of all time. The monthly dividend has been raised every year since the Nixon Administration. But the last two years of inflation and rising interest rates have been among the worst two years in this stock’s history. That makes it dirt cheap ahead of an environment that will almost surely at least stop getting worse. It’s probably the very late innings of the recent market dynamic and O is well positioned ahead of a likely shift in the future. It is still a great stock at a cheap price with retail staple properties and solid growth likely ahead. 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 thriving 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. WMB has gone sideways since last summer but the high dividend is safe and the company is well positioned for just about any environment going forward. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 3.5%) – ABBV is coming off a tough 2023 as it 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 beyond as management expects moderate earnings growth this year and robust growth next year. Management expects combined sales of just two of its immunology replacement drugs, Skyrizi and Rinvoq, will be $16 billion this year (Humira’s peak sales were $21 billion) and $27 billion in 2027. ABBV has broken out of the old range to a new all-time high as investors are starting to price in the company turning the corner on the way to a bright future. BUY

American Tower Corporation (AMT – yield 3.6%) – This cell tower property REIT surged far more than its peers in the last two months of last year as the interest rate trade reversed. But it has struggled through most of this year so far as interest rates moved up again amid the stronger economy. 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. The current dynamic should at least level off as interest rates and inflation are unlikely to rise nearly to the extent they have over the past couple of years. BUY

Broadcom Inc. (AVGO – yield 1.6%) – 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’s 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 21% YTD and 45% since early December. It’s also up over 200% since being added to the portfolio a little more than three years ago. AI provides certain technology companies with a huge growth catalyst that should last for years. Broadcom doesn’t report earnings until late next week. Anticipation is lifting the stock still higher. Hopefully, the party will continue. HOLD

Digital Realty Trust, Inc. (DLR – yield 3.5%) – The data center REIT reported earnings earlier this month that missed expectations and the stock is down 8% since the day of the report. Revenues grew 11% from last year’s quarter, 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 libel 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 it 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 over 30% YTD and has returned over 400% since being added to the portfolio. It never seems to stop trending higher. HOLD

Intel Corporation (INTC – yield 1.2%) – The red-hot chip maker finally cooled off after earnings guidance disappointed and the stock fell from the recent high. But the selling has ended and the stock has since leveled off. 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 with AI speculation still strong. 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 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 McKesson dominates a market that grows all by itself because of the aging population. MCK continues to roll forward. It’s been in an uptrend since the pandemic and just made another new high. It should continue to be a solid stock regardless of what interest rates or the economy does. BUY

Marathon Petroleum Corporation (MPC – yield 1.9%) – 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. This stock has consistently outperformed its peers and has been solid even in environments when the overall energy sector struggled. The stock should continue to thrive unless there is a recession. BUY

Qualcomm Inc. (QCOM – yield 2.1%) – Qualcomm is secretly one of the best semiconductor and AI stocks to own. But it has been held back by cyclicality, both in semiconductors and smartphones. But the negative cycle is coming to an end and QCOM is aching to surge higher. The Semiconductor Industry Association is forecasting 13% growth in worldwide chip sales this year after sales contracted 8% last year despite a rebound in the second half of the 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. It’s an AI beneficiary that just hasn’t really had its day yet. 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 0.7%) – This payments processing global goliath is thriving. V has been making a series of new highs since early November. It’s still in an uptrend that began in the fall of 2022. V was slow to recover from the pandemic because the global economy lagged. But now it’s making up for lost time. It’s up 10% YTD and will likely to continue rising slowly unless and until the economy tanks. Earnings last month beat estimates with upbeat guidance through 2024. HOLD

Safe Income Tier

Alexandria Real Estate Equities, Inc. (ARE – yield 4.3%) – The life science property REIT had mostly a terrible last two calendar years and interest rates rose and the REIT sector took it on the chin. Alexandria also got lumped in with office REITs, which are suffering from the work-from-home trend with low occupancy rates. But the company provides lab space and related offices that aren’t affected. ARE surged far more than its peers in the last two months of last year as the interest rate trade reversed. But it has struggled through most of this year so far as interest rates moved up again amid the stronger economy. Things might be changing though. ARE has broken the downside trend of the last two months while it remains one of the very best REITs on the market. BUY

NextEra Energy (NEE – yield 3.6%) – The past two years have been awful for this combination regulated and clean energy utility. But it’s cheap with a great long term track record. 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 trend lower for the year. The price has soared from the low of late October and has provided an 18% 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 3.7%) – 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 has seen 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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