The market continues to slowly slog higher in the dog days of the summer. It’s a time of year when investors are more focused on squeezing more fun out of the last days of the summer than investing. Markets seem to behave the same way they did when investors stopped paying attention. In this case it likely means a higher crawl until Labor Day.
Of course, an outside event can always change things. We’ll see what happens with today’s Fed rate decision. But unless something rocks the boat, markets will probably remain on autopilot for the next month or so.
Cabot Dividend Investor 719
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The Dog Days of Summer
We are in 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 dogs per se. The term refers to something the ancient Romans saw in the stars.
A star 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 thought the star generated extra heat and was responsible for the oppressively hot Roman summers, and named this time of the summer the “dog days.” No wonder that empire collapsed.
Of course, the malaise that comes with this time of year is probably even more ancient than the saying. It used to be that it was just too hot to do anything. Today, investors tend to get into a summer mode where they focus on enjoying the last days of the summer and it seems like everybody is always on vacation. It’s a time of year where the normal rules don’t apply and slacking becomes more acceptable.
Markets tend to continue with the same dynamic and personality that existed when investors stopped paying attention. That doesn’t mean that outside events can’t change things. And we’ll see what happens with today’s Fed rate decision. But unless something rocks the boat, the market tends to go on autopilot.
While investment decisions tend to get put off until after Labor Day and everybody is at the beach, it’s a good time to assess where we are and where we might be going in relative peace and quiet.
The S&P 500 is up over 20% so far this year and the market right about at all time highs as the market very slowly slogs a little higher. It is now the longest bull market and the longest recovery in history. That’s not a great place to be. The next recession is lurking somewhere. It feels like we’ve been playing musical chairs and the music had been playing for a really long time.
That said, there are reasons why this recovery is longer than average. It had been the slowest in the World War II era and the normal excesses haven’t built up. There was also strong stimulus in the form of tax cuts and deregulation at an unusually late stage of the economic cycle.
As I’ve mentioned in the past, I am generally positive about the direction of the market for the remainder of this year at least and probably into 2020. I think the economy is still solid and we are not bounding toward recession in the foreseeable future. But I do have a hard time seeing how the market is going to get a 50% or 100% upside move from here before the next recession.
Returns are likely to be uninspired from current levels. Dividends are likely to make up a bigger portion of total returns. The easy upside is likely over, making stock selection even more crucial to performance. It is increasingly difficult to find stocks that are not expensive and also have a catalyst to drive higher in the near future.
I haven’t found a stock that fits the bill this month. And I refuse to force things. Instead I have highlighted an existing portfolio position as this month’s “target buy.” I believe it is a better investment right now than any possible new additions to the portfolio that I researched. It’s still a great buy.
[highlight_box]What To Do Now: In the summer malaise, a similar dynamic continues. The safe stocks like food company MKC and Utilities NEE and XEL continue to slowly forge higher even with valuations getting high. As well, REITs CHCT, STAG and CCI continue to trend higher despite valuations as REITs continue to be loved by the current market.
These stocks could also get a boost from a Fed rate cut and are worth holding because of strong momentum. But most are rated “HOLD’ rather than “BUY” because of prices at the high side of the normal range. The exception to this group is healthcare REIT CHCT. That stock has shot up like a rocket, over 40% so far this year, and I’m taking a third of the position off the table ahead of next week’s earnings in order to protect some of the bounty that has accumulated in recent months.
The other “HOLD” rated stocks have different stories. Both MO and ABBV are value plays. They are fantastic companies selling at cheap prices, and buying good companies cheap has proven to be a successful investing technique over time. But they have lousy momentum and they could be cheap for a while. Patience should pay off over time but they may continue to languish. They are longer term plays that pay you a huge yield while you wait and have limited downside from here.
“BUY” rated CCI also has strong momentum and a relatively high price tag but it also has better growth prospects than the other REITs and safe stocks. Energy company EPD is “BUY” rated with strong growth prospects as well as a cheap valuation and a high dividend. And “BUY” rated refiner VLO is similar to MO and ABBV in that it is selling at a very low price. But price swings are more common for refiners than most other companies and commodity prices fluctuate from quarter to quarter. The stock is more aggressive than the other stocks in the portfolio but it takes less for it to start moving higher. The near term prospects for the stock are better than those of MO and ABBV.
My first pick at this particular point in time is “BUY” rated infrastructure company BIP. It is this month’s “target buy”.[/highlight_box]
Featured Buy
Brookfield Infrastructure Partners (BIP)
How do you generate high and consistent income in a low interest rate world? And more importantly, how do you do it without risking your shirt with the market near an all time high?
Dividend stocks or income paying securities, like REITs or MLPs, are some of the very few ways investors can still generate high income. But among these securities, a focus on those companies generating reliable and growing profits and cash flows with a stable business that can perform well in any economy can also deliver appreciation and protect your downside.
One of the best ways to generate a sustainable high cash flow in a low interest rate world is with real assets like real estate, pipelines, airports and farmland. Such assets provide tangible services that customers will pay for in both good times and bad.
Consider this. One of the most successful asset management companies is Brookfield Asset Management (BAM). The firm manages commercial property, power and infrastructure assets. Over the past 20 years the S&P 500 has provided an average annual return of about 6% while BAM provided an annual return of 17% over the same period, nearly triple the return.
Brookfield’s most successful subsidiary has been Master Limited Partnership (MLP) Brookfield Infrastructure Partners (BIP). Infrastructure is defined as the basic physical structures and systems essential to the operation of a society like water systems, power plants, ports, highways and bridges and the like. BIP owns and operates these assets all over the world including the following.
• Toll roads in South America
• Cell towers and data centers on three continents
• Railroads in Australian and North America
• Natural gas pipelines and storage facilities Australia and the US
• Utilities on four continents
• Ports in Europe
In all, the company currently operates 2,000 assets in more than 30 countries on five continents with a particular focus on high quality, long life properties that generate stable cash flows, have low maintenance expenses and are virtual monopolies. The formula has worked.
Over the past ten years BIP has been able to consistently grow cash flow by an average of 16% per year and the quarterly distribution has risen 284% over that same period. Since the IPO in 2008, BIP has provided an average annual return of 16.47%, compared to less than 9% for the overall market over the same period and with significantly less volatility. A $10,000 investment in 2008 would be worth $57,678 today, with dividends reinvested. But that’s in the past. What does the future look like?
The world is in an infrastructure crisis.
The American Society of Civil Engineers just gave the current state of our infrastructure systems a grade of D+. And the rest of the world is even worse. Developed countries all over the world have aging systems in desperate need of replacement. In emerging markets, systems are often woefully insufficient to accommodate growing urban populations and more advanced economies.
The G-20’s Global Infrastructure Hub estimates that a staggering $94 trillion global investment will be needed over the next several decades to get systems up to snuff. Of course, governments don’t have all those trillions lying around. More and more governments are partnering with private firms as well as selling existing assets to raise cash for other projects. The private sector is also stepping up.
Infrastructure is becoming a hot investment for private funds to the extent that it is almost becoming its own asset class. Limited partnerships, giant sovereign-wealth funds, multilateral and development-finance institutions are raising by some measurements trillions of dollars a year for infrastructure investments.
This creates huge opportunities for BIP. It is one of the few seasoned hands at this game with many assets and properties to choose from. It is responding to the opportunity in a couple of different ways.
Although BIP currently pays a stellar 4.55% yield on a payout that has increased at an annual rate of 10.4% over the past five years, it has a payout ratio of just 63.5% of funds from operations, very low for an MLP. This enables the partnership to retain funds to invest in new projects without having to borrow money or issue stock, giving it a big cost advantage.
In addition to retained earnings, BIP is also employing an assets rotation strategy to raise capital. The idea is to sell mature assets when returns have maximized and use the proceeds for higher return projects. The company started this strategy last year and the initial adjustment caused a rare bad year for the stock. Revenues went down as they sold assets that they had not yet replaced. But new projects have been coming on line this year and revenue growth is back.
The performance blip last year also makes the stock reasonably priced in an expensive market. This is a company and stock in the right place at the right time with a business model of proven success in a growing and increasingly popular sector. It’s important to note that these infrastructure assets generate a cash flow that is not only reliable but extremely defensive as they are depended upon in any economy. You get a strong 4.55% yield on a stock with good technical momentum right now that offers both upside potential and defense in a down market.
Brookfield Infrastructure Partners (BIP)
Security type: Master Limited Partnership (MLP)
Industry: Infrastructure
Price: $44.45
52-week range: $32.26 - $44.74
Yield: 4.55%
Profile: BIP was created by Brookfield Asset Management to own and operate infrastructure assets throughout the world.
Positives
• The stock has yielded better results than any other infrastructure play.
• 80% of cash flow is secured by regulated businesses and long term contracts.
• New money in the infrastructure area should provide an abundance of growth opportunities going forward.
• The stock offers high income and a defensive business.
Risks
• It will be difficult for BIP to continue to generate the returns it has over the past several years.
• Operates in countries where the political and regulatory environments can be uncertain.
• Competition for high quality assets is increasing.
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.
BUY – Brookfield Infrastructure Partners (BIP 44 – yield 4.6%) – The stock looks technically strong here. After a bad year in 2018 where the stock price fell over 20%, it has bounced back strongly this year, up about 30%. The stock is now within a whisker of the all time high of about $45 per share, reached in January of 2018. Brookfield will announce second quarter earnings on Friday. A better than expected quarter could blast the stock past the old high and into new territory.
Rating change “HOLD” to “SELL 1/3”
SELL 1/3 – Community Health Trust (CHCT 42 – yield 3.9%) – Nothing seems to stop this small healthcare REIT. It seems to forge higher every single week. It’s up over 40% already this year, more than double the return of the overall market. I’m not sure how much higher it can go. It is certainly getting to the high point of the trading range. Normally, I would just continue to ride the ceaseless momentum, but one thing makes me nervous. It announces earnings next Tuesday. This REIT has provided a 55% return since being added to the portfolio in May of 2018 and 47% of that return has been in 2019. It is probably prudent to take a little bit off the table here before the earnings report.
BUY - Enterprise Product Partners (EPD 30 – yield 6.0%) – The US infrastructure giant announced strong second quarter earnings this morning. Earnings easily beat Wall Street estimates but revenues missed the market. By most accounts so far it was a great quarter with gross profit growth of 41% and adjusted distributable cash flow up 21.3% over last year’s quarter. I’ll provide a more in depth analysis of the results next week. For now the market seems pleased as the stock is up over 2% on the day.
HOLD – STAG Industrial (STAG 30 – 4.6%) – Stag announced second quarter earnings yesterday. Earnings were in line with estimates and revenue missed slightly. Funds from operations increased 22.1% from last year’s quarter but earnings on a per share basis were even with last year’s quarter because the REIT issued new shares earlier this year. When the money from the proceeds gets put to work it should boost earnings. Things are solid. Despite a small miss in revenue expectations, revenues were up 13.1% year over year and Funds from Operations grew 22%. That’s strong growth for a REIT.
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.
HOLD – AbbVie (ABBV 67 – 6.1%) – Earnings came in better than expected last week and the stock got a small 2% gain on the news, which it has since lost. While the numbers were better than expected, expectations weren’t very high. Revenue fell 7.5% for the quarter on a year over year basis as increased U.S. Humira sales didn’t compensate for the 35.2% slippage in foreign sales. On the bright side, sales of new blood cancer drug Imbruvica grew 29.3% to over $1 billion for the quarter. As well, the company raised its full year adjusted earnings per share guidance for 2019, reflecting 12% year over year growth at the midpoint. The earnings turned out okay but not enough to meaningfully change the trajectory of the stock in the near term. It remains a hold because the dividend is safe and the stock is ridiculously cheap.
HOLD – Altria (MO 48 – 6.5%) – Altria reported earnings yesterday. Earnings were in line and revenues were better than expected. The company also reaffirmed the same earnings guidance for 2019. Earnings were up 11% over last year and revenues were 5.5% higher, but the company warned of slowing cigarette volumes. That spooked the market and the stock fell 3.6% on the day. The company said it expected cigarette volumes to fall 5% to 6% for the year, up from 4% to 6%. It also forecasted volume slippage of 4% to 6% through 2023, up from a previous forecast of 4% to 5%. It seems nitpicky but it reaffirmed investors’ central concern about the stock. It will start selling the popular heated tobacco product IQOS in September and there is still possible good news on the marijuana and E-cigarette fronts.
HOLD – American Express (AXP 126 – yield 1.2%) – Second quarter earnings were up 12.5% and revenues grew 8.4% over last year’s second quarter. It was also the eighth straight quarter of 8% or better revenue growth. Both earnings and revenues beat expectations but the stock stumbled because the company maintained the same guidance for 2019. The market was hoping for a guidance bump and was a little disappointed. When the stock is at an all time high, investors are more demanding. The stock is still strong but sputtering a tiny bit since the earnings announcement two weeks ago. It still has a strong upward chart pattern but we’ll have to see if it can resume its movement higher.
BUY – Crown Castle International (CCI 133 – yield 3.4%) – The stock pulled back for no good reason after announcing solid earnings and raising guidance for the year two weeks ago. But it looks like it’s back in business having gained back most of the slippage in the last week and a half. The REIT is in a very strong position as the 5G build-out continues in haste and demand for its towers grows. The only news in the past couple of weeks was some notable insider buying of the stock. That’s always good to see. It means people running the company think the stock is going higher.
BUY – Valero Energy Corp. (VLO 86 – yield 4.3%) – Valero reported earnings that were down from last year but better than expected. Earnings per share fell 30% year over year but earnings and revenues surpassed estimates by 10% and 18% respectively. I know, an earnings fall of 30% sounds awful. But this isn’t a utility company. It’s a refiner where profits can vary greatly from quarter to quarter. The lower profits were expected and already reflected in the stock price. Various prices are still not aligned great but will likely get a strong rebound in 2020. It’s also notable that Valero’s profits fell less than its peers because it’s a more efficient producer. And this quarter was an improvement over last quarter. Also its relatively new renewable diesel business is growing like crazy and it should also get a boost from the new IMO (International Maritime Organization) fuel standards in 2020.
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.
BUY- Invesco BulletShares 2019 Corporate Bond ETF (BSCJ 21 – yield 2.3%)
BUY – Invesco BulletShares 2021 Corporate Bond ETF (BSCL 21 – yield 2.8%)
The price is the same every single week on these things. And that’s what we want. They just keep rolling on at a steady price paying interest. When the market booms these ETFs seem like a waste and dead money but when things get ugly you’re happy you have these. Holdings like these add intangible effects like giving you more confidence to stay invested in the rest of the portfolio.
BUY – Invesco Preferred ETF (PGX 15 – yield 5.6%) – The high yield and lack of correlation to the stock and bond markets make this a nice portfolio holding and income generator. The stock price has barely budged for this entire year so far and that’s exactly what investors sign up for with this ETF. With rates likely to fall and the demand for income strong this ETF should continue to churn out high monthly income with a stable price in the foreseeable future.
HOLD – McCormick & Co (MKC 161- yield 1.4%) – The spice maker is up about 4.5% since it announced earnings last month. The company missed the revenue target but beat on earnings with impressive year over year growth of 14%. This is a very stable and defensive consumer stable company and is a Dividend Aristocrat, having raised the dividend for at least 25 straight years. The market loves stocks like this right now and McCormick continues to grow at a stronger rate than its peers. The stock keeps climbing slowly higher with no real signs of stopping.
HOLD – NextEra Energy (NEE 209 – yield 2.4%) – The country’s largest utility announced earnings this morning that beat estimates for both revenue and earnings. The company grew earnings in the quarter at a 13% clip over last year’s quarter and reiterated a target earnings growth rate of 6% to 8% through 2021, very high for a utility, especially one this size. The operational performance continues to be sound, the valuations aren’t out of whack, and the stock still has good momentum. It also has spectacular dividend growth. The combination of a stable utility with the growth of the green energy business makes this a stock every income investor should own.
HOLD – Xcel Energy (XEL 60 – yield 2.7%) – This utility is similar to NextEra in that it has a strong alternative energy business. But it’s a lot smaller which gives it potentially more upside. The company is doing well as earnings estimates have been raised for this year and next year. Over the past five years the price has moved 92% higher compared to just a 14.6% move for its peers over the same time span. The company will announce second quarter earnings tomorrow. They should be solid but we’ll see what happens.
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.
Fed Decision Day
The Federal Reserve Open Market Committee meets today to decide if the Fed Funds rate will be cut or remain the same for now. It is largely expected that the central bank will cut rates by 0.25%. In fact, financial exchange operator CME Group says that market traders foresee a 100% chance that the Fed cuts rates at this meeting.
Those are some high odds.
A 0.25% rate cut is already priced into the market and it won’t be happy if it doesn’t get it. But I think they will cut the rate. They almost have to at this point. A minority of traders expect a 0.50% cut but most traders expect another rate cut in September while about half expect a total of at least three rate cuts before the end of the year, according to CME. I’m not counting on any of that.
If the Fed does cut the rate it will be the first rate cut since December of 2008, in the midst of the financial crisis. The economy is a far cry from those days. It grew 2.9% last year and has been solid in the first half of this year. I can’t remember the Fed lowering rates in a strong economy in the late stages of the economic cycle. Is it a good idea? I have mixed feelings.
I don’t like it when the market goes up just based on Fed juice. If the rate cuts stimulate the economy I’m fine with it. But how much stronger is the economy really going to get if the Fed Funds rate is 2.25% instead of 2.50%? Rate cuts often lead the market higher through margin expansion, where stocks sell at higher valuation multiples as fixed rate investment become less desirable. So the market goes a little higher but then it gets to a more unstable place where valuations are too high. If the market can’t sustain itself on fundamentals, then let it go lower and get it over with. It’s healthier that way in the long run.
On the other hand, everything is relative. The U.S. isn’t an island. Sure, a 2.50% Fed Funds rate is still very low by historical standards. But relative to rates around the world it’s sky high. Some rates are even negative in Europe and Japan. Considering the rates in other countries, maybe the Fed has overdone it raising rates and this is a necessary adjustment to prevent the U.S. from being at a disadvantage.
It’s also true that the Fed’s involvement in the economy has been unprecedented during this recovery, as it kept the Fed Funds rate near zero for seven years and pumped trillions of dollars into the banking system with its bond buying programs. Central banks around the world have taken similar drastic and unprecedented measures. Look at it this way. If too much central bank involvement is going to doom the economy, that die has already been cast. At this point, what the heck, they might as well go for it.
We’ll see what happens. And I will certainly keep you posted. The main thing to realize in the near and intermediate term is that rate cuts tend to be very good for dividend stocks, as the return on alternative investments decreases. Many of the stocks that are already at high prices may run higher as a result.
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Your next issue will be published August 28, 2019
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