August 11, 2021

We’re in the middle of the summer market malaise. These markets tend to do whatever they were doing when investors went on vacation and stopped paying attention. The rubber usually hits the road when investors sober up and take a fresh look at things after Labor Day.

Sure, the market is historically cranky in September. Current fears about the Delta variant and inflation could gain more traction. The market could even sell off a bit. But I believe the current fears are overblown. Cyclical stocks and others that have been held back by recent concerns should shine again in the booming economy this fall.

In this issue, I highlight a stock with a strongly growing business that should thrive over the next several quarters as well as on the other side of the pandemic recovery. Meanwhile, it sells at a cheap valuation while the market is distracted by other things.

Cabot Dividend Investor 821

A Low-Priced Juggernaut for the Next Phase of the Bull Market
These are the dog days of summer, the hottest, most sultry days of the year. The expression “dog days” is an old one. In fact, it’s really old. The Romans used it.

It’s one of those expressions that everyone knows, but few people know the origin of the term. What does summer heat have to do with dogs? It actually has nothing to do with actual dogs. The term refers to something the ancient Romans saw in the stars.

A constellation visible in that part of the world at that time was called Canis Major, Latin for “The Great Dog.” It was so named because the constellation resembled the outline of a dog. The brightest star in the constellation was Sirius, also known as “the dog star.” It first dominated the sky in late July, corresponding to the hottest days of summer.

The Romans actually believed the star generated extra heat and was responsible for the oppressive heat in the late summer, and consequently named this time of the summer the “dog days.” No wonder that empire collapsed.

It’s also true that late summer slackery is probably even older than the saying. It used to be that it was too hot to do anything. Today, people scramble to enjoy the last days of summer before it slips away, and it seems everybody in on vacation.

Stocks tend to continue to do whatever they were doing before people went on vacation and stopped paying attention. And markets can’t seem to get much traction. The rubber usually hits the road after Labor Day. That’s when investors tend to sober up and take a fresh look at things.

What will they see?

Markets have a history of being cranky after Labor Day. Will growth concerns be a problem? Maybe inflation will again haunt the market. Right now, the market is in a tug-o-war between the booming economy and growth concerns, primarily being stoked by the delta variant.

Things are good. The economy is booming. The labor market is strong. And consumer demand is still spectacular. Meanwhile, interest rates are low, and the Fed is still pumping money into the system, as will the new infrastructure bill if it’s passed. But the new virus strain is in the headlines every day.

While the virus is highly unlikely to result in lockdowns like before, it will have a negative effect on growth. It’s already affecting travel and leisure activities. And, of course, things are worse overseas. China is a particular concern because it affects the global economy.

Sure, the market could sell off on these concerns in September. But I believe fears are overblown. It’s a weaker strain of the virus that’s likely to fade out fast. The negative effect on third quarter growth will likely be made up later, and the strong recovery will last longer. And inflation will likely prove temporary.

Fears about the virus, after earlier worries about inflation, have stopped the cyclical rally in its tracks since June. Companies with booming earnings and great prospects in the quarters ahead a getting shunned by this market. These companies should benefit when fears wane. And they offer an opportunity.

In this issue, I highlight a stock with a strongly growing business that should thrive over the next several quarters as well as on the other side of the pandemic recovery. Meanwhile, it sells at a cheap valuation while the market is distracted by other things.

Monthly Activity
July 14
Buy Blackrock Enhanced Capital and Income Fund (CII)

August 4
KKR & Co. (KKR) – Rating change “BUY” to “HOLD”
U.S. Bancorp (USB) – Rating change “BUY” to “HOLD”

August 11
Buy Spectrum Brands Holdings (SPB)
Digital Realty Trust (DLR) – Rating change “BUY” to “HOLD”

What to Do Now
It’s a confusing market. The indexes have rallied over 100% since the bottom in March of 2020. And fears abound over the new virus strain and inflation. It seems like a perfect storm for a slap in the face after Labor Day.

But don’t forget that the economy is booming. Earnings growth has been spectacular. Meanwhile, interest rates are low, and consumers are flush with cash and confidence. Markets seldom enjoy such a friendly habitat. Something had to slow the market down. And recent fears have done the job.

Growth fears have stopped the cyclical rally in its tracks since June. Portfolio positions in energy and finance has languished over the summer as a result. But business in these companies is still booming and will likely continue to do so for several quarters while prices are still below pre-pandemic levels.

There is opportunity in energy positions Chevron (CVX), Valero (VLO), ONEOK (OKE) and Enterprise Product Partners (EPD). The rally in these stocks ended before they returned to fair value. But the recovery is forging on, and these stocks should get another price surge when the current fears wane.

There’s also the yield curve trade. The 10-year Treasury rate fell from 1.75% in March to below 1.2% early this month. Companies that benefit from a steep yield curve, the difference between short- and long-term rates, have taken a hit, namely AGNC Investment Corp (AGNC) and U.S. Bancorp (USB). But this yield curve fear is likely overblown.

The 10-year rate averaged between 2% and 3% before the pandemic. Now there’s higher levels of economic growth and activity, as well as persistent inflation. The dip in rates is silly. The 10-year benchmark and longer-term rates are likely to trend higher from here and AGNC and USB should benefit.

It may seem counterintuitive to buy these cyclical and yield curve stocks now. But that’s why they’re a bargain.

Featured Stock

Buy Spectrum Brands Holdings, Inc. (SPB)
Yield 2.1%
Spectrum is a global branded consumer products and home essentials company. It was formed in 2005 when battery company Rayovac added more brands and changed its name. The company offers popular well-known brands including George Foreman Grill, Kwikset Lock, Cutter Bug Repellent, Remington and Black & Decker products.

Despite the fact that SPB has outperformed the S&P 500 over the past year, it still sells at a low valuation of just 12.5 times forward earnings. However, the stock has underperformed over the past several months for what are, in my opinion, misguided concerns.

Spectrum operates in four segments: Home Improvement, Personal Care, Pet Care and Garden Supplies. The products are very home centric. That served it well during the pandemic as people focused on the home during the lockdowns. In fiscal 2020 (which ended last September) earnings increased 43% over the previous year. As a result, SPB has returned over 200% since the market bottom in the pandemic, more than doubling the S&P 500 return over the same span.

But the stock price has languished since May and has fallen over 15% from the high. It may be getting cast as a pandemic stock whose time is up. Last quarter’s earnings missed expectations as the company reported higher costs from commodity and freight inflation as well. But these issues should fade away.

The consumer is loaded. Confidence is sky-high and so are savings rates. The pent-up consumer demand is still strong and should have a long way to go. Plus, the home focus is lasting beyond the pandemic. Most analysts in the field believe the trend is here to stay. It was a trend likely to grow anyway that was simply accelerated by the lockdowns.

Spectrum is also a turnaround story. The company filed for bankruptcy in 2009 and slowly climbed back. Lately, it has made huge strides. The current management team has cut net debt in half in the last four years. Operating earnings cover debt payment by 3 times today compared to 1.5 times in 2019. The company has also massively cut costs.

Then there’s inflation. The supply problems and rising costs are likely to be temporary as economies recover. Even if it lasts, the company will likely be able to pass most of the higher costs on to the consumer. It’s a weird issue with peculiarities to this quarter that is unlikely to have a lasting negative effects.

Analysts are expecting earnings-per-share growth of 52% this year despite last year being strong and an average of 18% over the next five years. Meanwhile, SPB sells at a valuation well below that of its peers. It’s a great chance to buy the stock while it’s caught up in temporary market gyrations. Earnings and results almost always win in the end.

Ten of the 12 analysts covering the stock rate it a “BUY” or “STRONG BUY” with an average target price of 110 per share, 35% higher than the current price.

Spectrum Brands Holdings, Inc. (SPB)
Security type: Common stock
Industry: Consumer staples
Price: $81.27
52-week range: $54.52 - $97.27
Yield: 2.1%
Profile: Spectrum is a leading global branded consumer products and homes essentials company.

Positives

• Demand for home products will remain strong beyond the pandemic.
• The consumer is strong, confident and flush with cash and pent-up demand.
• The stock is cheap and knocked back for reasons that should prove temporary.

Risks

• The company still has a high level of debt.
• Inflation could prove to be a longer-lasting problem than currently expected.

Portfolio at a Glance

Portfolio Updates

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.

AGNC Investment Corp. (AGNC – yield 9.0%) – It’s all about the yield curve with this mortgage REIT. And it’s been going the wrong way. AGNC benefits as the yield curve steepens and it has been flattening. The 10-year Treasury yield has fallen all the way to 1.2% from a post-pandemic high of 1.75% at the end of March. As a result, the stock price fell from a high of nearly 19 per share in early June to 16 today.

Yet, I continue to recommend AGNC. The reason is that I believe the yield curve flattening is a temporary situation that should reverse over the rest of the year. The 10-year averaged between 2% and 3% prior to the pandemic. The economy is booming, and inflation is high. The pressure from here should be higher, and the yield curve should steepen. BUY

Blackrock Enhanced Capital and Income Fund (CII – yield 5.2%) – This newest portfolio addition covered call ETF tends to move roughly in sync with the overall market. Writing calls to enhance income is a great strategy in a market that is trending higher but not delivering fast returns. The higher monthly payout provides a great income return while the overall market bounces around. In a rising market the call premium, and the dividend, go up. In a flat market, CII provides a solid income while stock prices languish. BUY

Enterprise Product Partners (EPD – yield 8.0%) – The midstream energy partnership reported solid earnings that failed to impress. Volumes continued to increase as did earnings and cash flow. But it didn’t take that big a hit in the pandemic and the economy was still largely shut down in the first half of this year’s second quarter.

Volumes and earnings should get a bigger boost in the second half of the year as midstream business gets full quarters of an open economy. The stock price has been bouncing around and is at the level it was at in March after the latest dip. The market just doesn’t like energy right now. But things change. Patience should pay off and the stock still pays a massive yield while you wait around for better things. BUY

ONEOK Inc. (OKE – yield 7.1%) – Despite great earnings that exceeded expectations, OKE continues to languish. It’s a similar problem to EPD. The market moved away from cyclical stocks in a necessary consolidation after a big run. But now, the Delta variant is creating worries about growth. But business at ONEOK is booming and will continue to do so for several quarters. The market won’t sour on a great valuation, and a high and safe dividend for too long. BUY

Realty Income (O – yield 4.0%) – This is the legendary “monthly income company” that has consistently paid a monthly dividend since the Nixon Administration. The overall performance may not light the world on fire, in the short term anyway. But you get a reliable regular income with a stock price that tends to appreciate over time. It still sells at a good value and business is improving in the recovery and likely will continue to do so for a while. BUY

STAG Industrial (STAG – yield 3.5%) – This industrial REIT has the right stuff for this market. It pays a high monthly dividend in a low-interest-rate world that is starved for income. It’s also more cyclical than its REIT peers, which is a good thing when the economy is booming. Plus, there is a terrific supply/demand dynamic for industrial and e-commerce properties that should have plenty of growth opportunities going forward. It’s also a great place to be in an uncertain market heading into Labor Day. Those are the reasons it’s at all-time highs. HOLD

Verizon Communications (VZ – yield 4.5%) – The wireless giant beat earnings expectations on both revenue and earnings per share because of 5G phone upgrades. That’s good news and indicates that the strategy of investing heavily in 5G is starting to work and hit the bottom line. Of course, you wouldn’t know it by the stock movement. The stock continues to float on the water like whale excrement. Perhaps the post-Labor Day market will infuse the market with newfound enthusiasm for the 5G phenomenon. We’ll see. It’s also a solid down-market stock. 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 4.5%) – Earnings were strong as sales of cosmetic treatment Botox, from newly acquired Allergan, are rebounding strongly as people venture out again after the lockdowns. But the stock is still cheap because of fears of competition for the blockbuster Humira drug when is faces biosimilar competition in the U.S. in 2023. But the merger reduced reliance on Humira which is now about 43% of sales versus 65%. Plus, the new generation of autoimmune drugs (Skyrizi and Rinvoq) should do nearly $5 billion in sales this year. The company is well positioned to overcome slipping 2023 Humira sales and the market seems to be realizing it. BUY

Broadcom Inc. (AVGO – yield 3.0%) – The chip maker benefits when new technologies proliferate. It should also benefit in the near term as 5G rolls out. Longer term, as 5G enables new technologies, artificial intelligence, self-driving cars and many other things is will prime demand for Broadcom’s products. Remember, 90% of all internet traffic uses Broadcom’s products at some point. The recent lackadaisical performance in the sector and the stock should be short lived. We’re in the midst of a technological revolution and AVGO is a great place to be. BUY

Brookfield Infrastructure Partners (BIP – yield 3.7%) – The infrastructure partnership reported solid earnings last week. The number would have been higher but for recently sold assets where the money had not yet been deployed but will be in future quarters. BIP is a slow mover that has performed on par with the overall market during the recovery. That’s not bad considering all the excitement and focus has been elsewhere. Relative returns should improve as the pace of the bull market recedes. Plus, Congress is on the cusp of passing an infrastructure bill that could make the investment subsector a lot more popular. BUY

Chevron Corp. (CVX – yield 5.3%) – I get it. Energy is “out” this summer. It was hot stuff early in the year, but investors have soured. A lot of the issue was growth concerns that are proving unfounded as earnings far exceed expectations and the economy roars. But now, worries about global energy demand amidst the Delta variant virus surge is putting pressure on the sector.

I don’t know how this will play out in the near term. But I can tell you one thing, Chevron’s profits are absolutely soaring. Revenue was up 179% last quarter over last year’s quarter. And it wasn’t even a full quarter of an open economy. The pace may stumble a little bit on the way, but energy demand will continue to increase for many quarters, and CVX is still below the pre-pandemic price while business will be a lot better. HOLD

Rating change “BUY” to “HOLD”
Digital Realty Trust (DLR – yield 3.0%) – The world’s largest provider of data center properties is operating well. Last quarter’s revenue grew at 10%. That seems quite unimpressive for this quarter with average earnings up about 90%. But it’s important to note that this REIT thrived during the pandemic. There is no bounce back from boom times. These are “normal economy” growth numbers. DLR is one company that is already thriving in the post-pandemic economy. It’s also a terrific down-market stock if things get dicey after Labor Day.

That said, DLR has vastly underperformed the overall market over the past year. It has also made a double top which could indicate stiff resistance at the current level. The stock will be reduced to HOLD until it shows evidence of breaking through to a new level. HOLD

Eli Lilly and Company (LLY – yield 1.3%) – This stock is absolutely on fire. LLY is up over 60% YTD and over 35% since the beginning of June. It first got a huge boost when Biogen’s Alzheimer’s drug got FDA approval, greatly increasing the odds that Lilly’s more promising Alzheimer’s drug will be approved. The drug could be a mega-blockbuster as there are almost no treatments for the common disease. It got another boost after the earnings report stated that it will submit the drug for fast approval before the end of the year.

Aside from that, the company has a spectacular pipeline and a strong track record of delivering, which is why the position was added to the portfolio a year ago. I don’t like to bet on any one drug. I’ve been burned too many times. But this one does look exceptionally likely. When this latest surge runs out of gas, I will probably look to take partial profits, as the stock typically pulls back for a while after a big run. But I don’t want to interrupt it while it’s still moving higher. HOLD

KKR & Co. Inc. (KKR – yield 0.8%) – This alternative investment asset manager is killing it too. It has returned 70% YTD and is up 17% in just the last several weeks. The asset management business is booming, and alternative investments are the fastest growth segment of that business. Earnings were spectacular as distributable earnings more than doubled and revenues tripled over last year’s quarter and KKR took in a record $59 billion in new assets. Let’s see how much further it can run. HOLD

Qualcomm Inc. (QCOM – yield 1.8%) – The 5G chip maker delivered another blowout quarter, thrashing estimates and raising guidance. Qualcomm is making a fortune on royalties as 5G phones are selling like hotcakes. But the stock has been kind of a dud since early February and is still down 13% from the high. QCOM got a boost from earnings and is back to the highest level since February. It’s cheap with exploding earnings and the market never sours on technology for too long. BUY

U.S. Bancorp (USB – yield 3.3%) – Even USB has been languishing since cyclical stocks turned loser in June. The bank reported great earnings, but that only temporarily staved off the gradual recession in price. As with AGNC, it’s about the yield curve. As a regional bank, USB makes a lot of its profits from interest rate spreads. That said, the strong economy should enable the stock to maintain the current price level. And there’s a good chance that the recent interest rate decline is overblown and longer rates will trend higher from here. The move may have already started. HOLD

Valero Energy Corp. (VLO – yield 5.9%) – Just about everything I said about CVX is true of VLO, except VLO is a higher-leverage play on energy and the recovery. The stock was still bouncing around near the post-pandemic highs in late June but has taken it on the chin since the cyclical trade soured. But business should be booming over the second half of the year and the stock is still cheap. It’s a bucking bronco that should be worth the ride. 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 1.5%) – 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 4.9%) – After falling during the pandemic, this preferred stock ETF has recovered and is back to the pre-pandemic high. 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. HOLD

NextEra Energy (NEE – yield 1.9%) – It looks like this alternative energy utility is benefitting as investors sour on the cyclical stocks. NEE has been trending nicely higher since the moment cyclical stocks started to weaken in June. It’s a great stock for the longer term as alternative energy continues to grow at warp speed and it gets cheaper to produce. But NEE has had an uncharacteristic subpar year in the open-up craziness. Recent strength and weakness in the stock has been anchored on short-term sector rotations. But now, the short-term factors are benefitting NEE and the long-term prognosis is excellent. BUY

Xcel Energy (XEL – yield 2.7%) – This smaller alternative energy utility delivered uneventful earnings. EPS grew at a solid 7.4% clip, which surpassed estimates, and the company reiterated the same yearly guidance. The stock has been trending higher since late June after a recent low. It should benefit when alternative energy stocks come back into vogue. 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 September 8, 2021.

Cabot Wealth Network
Publishing independent investment advice since 1970.

President & CEO: Ed Coburn
Chief Investment Strategist: Timothy Lutts
Cabot Heritage Corporation, doing business as Cabot Wealth Network
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