While the direction of the market is highly unpredictable in the short term, it’s a safe bet that this economy will continue to recover after the covid recession. It is also highly likely that interest rates will continue to rise.
Interest rates tend to move higher as the economy emerges from recession and gains traction. It’s already happening. The benchmark 10-year Treasury bond yield has already risen sharply this year. Yet, rates are still well below pre-pandemic levels, and the economy is about to ignite. There will also be trillions in stimulus dollars causing inflationary pressures and upward pressure on rates.
Certain dividend stocks and income paying securities endure despite rising rates. And certain special securities can actually thrive. In this issue, I highlight an investment that loves rising rates. In fact, profits increase directly as a result. The stock pays a stratospheric 8.4% yield and pays dividends every month.
In this issue, I highlight an investment that loves rising rates. In fact, profits increase directly as a result. The stock pays a stratospheric 8.4% yield and pays dividends every month.
Cabot Dividend Investor 421
Don’t Fear Rising Rates, Exploit Them
This is an unusual environment to say the least. The market is looking ahead to the highest GDP growth in decades as vaccines end the lockdowns and restrictions. And forecasts continue to rise. At the same time, trillions in government stimulus will flood into the economy.
The S&P 500 has now risen over 80% from the pandemic bear-market lows of last year. And the market continues to forge ever higher with little interruption.
When will stocks have priced in all that good news? How much does a market that is already up over 80% have left in the tank? At what point will the market start to look past the pandemic recovery and fret about higher taxes, rising interest rates, tougher comparisons and all that stuff? It’s impossible to say.
There is no “fair value” for stocks. The fair value is whatever investors say it is. And those opinions are often swayed by headlines. It is likely that stocks will find their way still higher over the course of this year if the ideal environment expected comes to fruition. And it probably will. But there are no guarantees.
The whole Covid fandango showed us how unpredictable the future can be. The fact is that no matter how good or how bad things seem, the market is always unpredictable in the short term.
I find general trends to be more predictable than near term market gyrations. For example, it’s a safe bet that this economy will continue to recover after the covid recession. It is also highly likely that interest rates will continue to rise.
Interest rates tend to move higher as the economy emerges from recession and gains traction. It’s already happening. The benchmark 10-year Treasury bond yield has already risen from 0.92% to 1.75% in the first three months of this year. But rates are still well below pre-pandemic levels, and the economy is about to really take off.
The 10-year bond averaged between 2% and 3% in the years prior to the pandemic. Goldman Sachs is predicting GDP growth of 8% for 2021, which would be the highest since 1951. Plus, there will be trillions of dollars in stimulus floating around, causing inflationary pressure.
Under these wacky circumstances, it seems highly likely that rates at least get back to where they were before the pandemic, and maybe higher. Of course, rising rates are bad news for bond investors, as bond prices tend to decline. The likely specter of higher rates makes income investing even more challenging.
Fortunately, certain dividend stocks and income paying securities endure despite rising rates. And certain special securities can actually thrive. In this issue, I highlight an investment that loves rising rates. In fact, profits increase directly as a result. The stock pays a stratospheric 8.4% yield and pays dividends every month.
Of course, as with stocks, there are no guarantees on the course of interest rates. But doesn’t it make sense to have something in your portfolio that actually benefits if rates do rise?
What to Do Now
The market continues to forge relentlessly higher. Several sectors that had been left out of the earlier part of the rally are joining the fun. The rally has much more broad participation and continues to inch ever higher with remarkably low volatility.
The market has been downright boring with not one day in the last two weeks with a 1% move. But boring tends to be very good for stocks. In 2017, the market rise was slow and steady with record low volatility. There’s a Wall Street saying: never short a dull market.
While I remain positive for the market prospects over the rest of the year, it is highly unlikely we will see returns like we saw over the past year. Sure, a Promised Land of booming GDP growth and trillions in stimulus lies ahead. But expectations are also rising.
The economy and the market have well exceeded expectations at every point in this recovery. But now GDP growth forecasts for the rest of the year are through the roof and rising. The market also expects 25% earnings growth on the S&P 500 in the first quarter. It’s going to be much harder for the economy and companies to impress going forward.
It’s easy to get spoiled in a market like we’ve had. But expect more down-to-earth returns going forward. Dividends will likely play a larger role in total returns and dividend paying stocks should see increasing investor demand and better relative performance in the months ahead.
The huge upside moves that we got in Innovative Industrial Properties (IIPR) and Qualcomm (QCOM) as well as in the energy stocks Valero Energy (VLO) and Chevron (CVX) probably won’t happen going forward. But I expect solid performance throughout the portfolio nonetheless.
I still like the energy stocks in the portfolio, despite the huge recent upside move and pullback, as well as the technology stocks (QCOM and AVGO), despite the recent pullback in that sector. It is also likely that the REITs and utility stocks in the portfolio provide stronger returns going forward.
The portfolio already took profits in the high market. The remaining positions are still worth holding or buying. Of course, things can change, and I will keep you posted.
Featured SToCK
Buy AGNC Investment Corp. (AGNC)
Yield 8.4%
AGNC is a mortgage real estate investment trust (mREIT) that invests predominantly in U.S. Government backed residential mortgages. It pays a high dividend yield, currently 8.4%, and makes dividend payments on a monthly basis.
While typical REITs own actual physical real estate properties, charge rent, and pass that income onto shareholders, mortgage REITs are a different animal. They buy mortgages and generate income from monthly mortgage payments. A mortgage REIT borrows money at low short-term rates and uses that money to buy mortgages that pay a higher interest rate, making a profit on the difference in rates, or the net interest spread.
AGNC invests almost entirely in mortgages backed by Fannie Mae and Freddie Mac, so there is virtually zero credit risk. However, there is certainly interest rate risk. It’s all about the spread. If the difference between the short-term rates at which it borrows money and the mortgage interest paid increases, so do profits. When the spread decreases profits fall.
Mortgage REITs and AGNC are not good investments to buy and forget about. The long-term total returns tend not to be very good. There are good times and bad times to own these securities. I believe now is a very good time. Here’s why.
Mortgage REITs are coming out of a bad time. Prices fell sharply in the pandemic bear market as interest rates crashed and credit concerns in a recession dragged the sector down. The price of AGNC fell 50% in a little over a month during the tumult. But the situation has vastly improved since. The economy is stable and recovering, and longer-term interest rates are moving higher.
AGNC cut the dividend last year in an abundance of caution from $0.15 per month to $0.12. But as the environment has rapidly improved, the CFO recently said that the cut was probably not necessary. In the third quarter AGNC earned a net interest spread of $0.81 per share, more than enough to cover the $0.36 in dividends paid during the quarter.
The main story going forward is about interest rates. The Fed has a lot of control over short-term rates, as they set the benchmark Fed funds rate, which is currently near zero. The Central Bank has indicated that short-term rates will remain at current levels for some time. The bank has less control over long-term rates as the economy strengthens.
As I mentioned, the 10-year treasury rate, a benchmark for longer-term rates including mortgages, is already on the rise. It has more than tripled from the low of 0.50% in the midst of the bear market. It stands to reason that if the fuller economic recovery that the market is already pricing in comes to fruition, rates should climb further. And there’s room to run. The 10-year rate was over 3% in 2018.
With longer rates and mortgage rates rising and short-term rates staying the same, the net spreads and profits at AGNC are likely to climb. The stock has also been consistently climbing for the past year, but it is still below pre-pandemic levels.
AGNC pays a massive yield of 8.4%. And that stratospheric payout comes in payments every single month. It’s great for cashflow. And the yield should be safe or even growing as profitability increases. A fat yield with a good prognosis for the stock price should make AGNC a big winner for income investors.
AGNC Investment Corp. (AGNC)
Security type: Real Estate Investment Trust (REIT)
Category: Finance, Mortgages
Price: $17.07
52-week range: $10.48 - $17.09
Yield: 8.4%
Profile: AGNC is a mortgage REIT that invests primarily in mortgage securities of U.S. government agencies.
Positives
- Interest rates are trending higher and increasing spreads earned and profits.
- The stock is on a strong uptrend.
- Shares are still priced below pre pandemic levels ahead of an environment that is likely to be better.
Risks
- This is not a good stock to own in a recession or times of falling rates.
- The Fed could raise short term rates and narrow the spread.
Portfolio at a Glance
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Portfolio Updates
March 10
Buy KKR & Co. (KKR)
Chevron (CVX) – Lowered rating from “BUY” to “HOLD”
March 24
Altria (MO) – Lowered rating from “BUY” to “HOLD”
Invesco BulletShares 2021 Corporate Bond ETF (BSCL) – Lowered rating from “BUY” to “HOLD”
April 7
Altria (MO) – SELL HALF
April 14
Purchase AGNC Investment Corp. stock (AGNC)
High Yield Tier
The investments in our High Yield Tier have been chosen for their high current payouts. These investments will often be riskier or have less capital appreciation potential than those in our other two tiers, but they’re appropriate for investors who want to generate maximum income from their portfolios right now.
Altria (MO – yield 6.7%) – The cigarette maker stock has had a huge 43% move higher since the beginning of November. It apparently came back into favor with investors for its high income but there was also positive news. It was upgraded by a prominent analyst on the notion that the market is underestimating its offsets for tobacco volume slippage (e-cigarettes, heated tobacco, marijuana). The target price was raised to 58 per share.
MO broke out of the lame range in which it had traded since the pandemic. It also might be breaking out of the long-term downtrend it’s been in since 2017. The rise has leveled off and I’m not sure where it goes from here. We sold half of the position last week in case this is as good as things get and it’s at a near-term high and kept the other half in case it can get more traction and move still higher. HOLD
Enterprise Product Partners (EPD – yield 7.8%) – This midstream energy partnership is tough to figure of late. It is still below the mid-March high. But it never rose as much as the energy sector index while energy stocks were red hot between the beginning of February and mid-March. Profits never went down that much during the pandemic and investors flocked to energy companies with more dramatic earnings rebounds. But EPD is still on an unmistakable uptrend that began in November. And it has gotten overextended. It’s still a great value well below the pre-pandemic level and that huge yield is rock solid. BUY
Realty Income (O – yield 4.3%) – The time may be finally arriving for this legendary income REIT. It’s had a 10% move higher over the last month and is very close to a post-pandemic high. It helps that REITs have been the top performing market sector over the last month. Realty is still a value at a price well below the pre-pandemic high with strong and rebounding earnings. Hopefully, it can keep going. BUY
STAG Industrial (STAG – yield 4.2%) – This monthly-paying industrial REIT just made a new all-time high. After wallowing in oblivion for several months, STAG has been trending sharply higher since late January. REITs are coming back into vogue and STAG is a particularly cyclical REIT because of its industrial properties. That gives it two good things going for it right now. Hopefully this one can run higher for longer. BUY
Verizon Communications (VZ – yield 4.4%) – It might be decision time for this wireless giant in the weeks ahead. VZ has been a very range-bound stock for the past few years, regardless of what the overall market does. It’s now approaching the high point of that range in the low 60s per share. If VZ does indeed ride this recent rally back to the high point, we might sell some of the position and leave the rest to see if the stock gets a boost from 5G. HOLD
Dividend Growth Tier
To be chosen for the Dividend Growth tier, investments must have a strong history of dividend increases and indicate both good potential for and high prioritization of continued dividend growth.
AbbVie (ABBV – yield 4.8%) – The stock has been forming a flat base near the top of its recent range. Health care sector performance has not been great but ABBV has been hanging tough after a big price surge and not pulling back like it usually does. That’s a very positive indication for the stock going forward. It has five significant new FDA approvals as well as many important late-stage trial results coming down the pike in the months ahead. The stock is also still very cheaply valued at less than 9 times forward earnings with a high and safe dividend. When the stock gets a move on, I will likely upgrade to a BUY. HOLD
Broadcom Inc. (AVGO – yield 3.0%) – This semiconductor and business software giant should be a phenomenal holding as technology proliferates at ever higher rates and 5G will enable a host of new technologies. This company grew revenues 16 times over in the last 11 years. It isn’t hard to understand why because, as the company claims, 99.9% of all internet traffic crosses at least one of their chips. Technology has been consolidating recently, but the high-growth sector will be back on the move before long. BUY
Brookfield Infrastructure Partners (BIP – yield 3.7%) – This desirable infrastructure juggernaut looks to be finally breaking out. It just made a brand new all-time high and is still very much in the midst of an uptrend that started over a year ago. It had been moving kind of sideways for several months after the vaccine announcement as investors flocked to cyclical stocks. But more defensive plays have come alive again, and BIP is one of very best of that ilk. All this infrastructure talk should also pique investors’ interest in the subsector going forward. For added measure, BIP should have a strong year for earnings growth. BUY
Chevron Corp. (CVX – yield 5.0%) – I don’t think energy is done yet. Sure, the torrid advance of the sector in past months couldn’t last without a consolidation. We are likely headed to an energy Promised Land as GDP grows the most in decades as people taste freedom again. Plus, all those trillions in stimulus are likely to cause some commodity price inflation. Chevron, as perhaps the very best large-company player in the space, should certainly benefit. I don’t know when CVX will start moving higher again, but it should be worth the wait. HOLD
Digital Realty Trust (DLR – yield 3.3%) – The recent cyclical rally taught us that holding onto unloved stocks can pay off. Although there still isn’t any concrete technical evidence of a breakout, DLR has trended higher over the past 5 weeks. It has a growing business in technology infrastructure while paying a solid dividend. Sure, it’s been on a cold streak. But investors should again be lured to its charms before too long. BUY
Eli Lilly and Company (LLY - yield 1.8%) – This biopharmaceutical giant soared after a plethora of good news in December and January. Then healthcare went out-of-favor, but it held its gain. Then it got a badly perceived trial result from its potential mega-blockbuster Alzheimer’s drug and pulled back. It also recently ran into an FDA delay in the approval process of its Olumiant drug and ended sales to the government of its covid treatment drug.
That’s life for a big pharma company. All the news doesn’t stay good forever. But none of these developments changes the fact that this one of the very best big pharma companies with a spectacular pipeline. And the stock has a history of pulling back after a big surge. You should get further rewarded by being patient with LLY. HOLD
KKR & Co. Inc. (KKR – yield 1.1%) – This alternative investment wealth management company stock just keeps inching higher, even on bad days for the market. It’s still trending sharply higher on a move that began in late October. The rest of the year looks promising for the financial sector and KKR is in a strong growth area. Hopefully, it keeps trending higher. BUY
Qualcomm Inc. (QCOM – yield 1.9%) – The stock got hit with disappointment over lower-than-expected 5G smartphone royalties because of industry-wide supply shortages. Then the tech sector got knocked back. But QCOM should be in a great position once the short-term issues get sorted out. The market looks ahead, and Qualcomm will make up for the last sales down the road. The stock has been trending higher from the short-term bottom in early March. The reawakening may have already commenced. HOLD
U.S. Bancorp (USB – yield 3.1%) – Even in a choppy market, USB is consistently trending higher. It appears poised to run back to the pre-pandemic high of 60 per share in the weeks ahead. It’s simple. U.S. Bancorp is a great bank and the environment continue to look ideal for banks. The economy should take off as most of the remaining restrictions come down. Interest rates are all but certain to trend higher. BUY
Valero Energy Corp. (VLO - yield 5.5%) – The same general dynamic that I mentioned about CVX applies to this refiner stock, except to a larger degree. It pulls back more than the energy sector when it consolidates and soars higher and faster when it gets back on track. The full recovery is still coming and the refining business will benefit mightily. Meanwhile, VLO is still well below pre-pandemic levels while the environment ahead is likely to be a lot better. It may continue to consolidate for a while longer, but the stock should be back in business before too long. HOLD
Safe Income Tier
The Safe Income tier of our portfolio holds long-term positions in high-quality stocks and other investments that generate steady income with minimal volatility and low risk. These positions are appropriate for all investors, but are meant to be held for the long term, primarily for income—don’t buy these thinking you’ll double your money in a year.
Invesco BulletShares 2021 Corporate Bond ETF (BSCL – yield 1.9%) – This short-term bond fund is a safe port. While the market is promising for the rest of the year, there are still a lot of uncertainties out there. It’s nice to have something in the portfolio that you don’t have to worry about. That said, the bonds in this ETF mature at the end of this year. HOLD
Invesco Preferred ETF (PGX – yield 5.0%) – This preferred stock ETF is much less volatile than the stock market while providing a big yield. It also adds diversification as preferred stock performance is historically not correlated to the stock and bond markets. Since falling sharply in the worst of the bear market, the fund price has recovered to pre-pandemic levels and then leveled off. It should continue to be a solid holding from here, even with interest rates rising. HOLD
NextEra Energy (NEE – yield 2.0%) – This combination regulated and alternative energy utility stock had a rare selloff during the cyclical rally in February and early March. It’s had a rare departure from the normal uptrend ahead of a very promising environment for alternative energy stocks. Washington will likely not only offer tax breaks and other goodies but should make the sector stand out to investors. Plus, everything that was true about the company when it was flying high is still true. BUY
Xcel Energy (XEL – yield 2.7%) – Most of what I said about NEE is true for this alternative energy utility, except it moved down sooner and more and has recovered sooner and steeper. XEL is up almost 20% since early March, and it looks like it still wants to run higher. I like this for both the short and long term. BUY
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 estimated.
The next Cabot Dividend Investor issue will be published on May 12, 2021.
Cabot Wealth Network
Publishing independent investment advice since 1970.
President & CEO: Ed Coburn
Chairman & Chief Investment Strategist: Timothy Lutts
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