Cyclical or open-up stocks are on fire, and for good reason.
The U.S. economy has far exceeded expectations at every phase of the recovery so far. The vaccines promise to end the remaining lockdowns and restrictions. With the shackles removed, the economy will kick into high gear. Even several normally dour economists are predicting the highest GDP growth in decades this year.
In anticipation, cyclical financial stocks are on fire. The Financial Sector SPDR Fund (XLF) is up 45% just since the vaccine announcement in early November. Yet, many financial stocks are still undervalued ahead of what should be an ideal environment for the sector.
In addition to the bright near-term prospects for financial stocks in general, there is also an incredible growth trend in a particular niche area, alternative investments. These include investments outside of the stock and bond markets. Individuals and institutions desperate to diversify are piling in. And massive growth in this arena is accelerating.
In this issue, I highlight a company I believe to be the very best player in alternative investments. Stock performance has far exceeded its peers and there is every reason to believe the outperformance will continue going forward.
Cabot Dividend Investor 321
A Superstar in a Financial Megatrend
This is a wild market. Yesterday’s perennial losers are today’s big winners. At the same time, long dominant technology stocks are taking a beating. Cyclical or open-up stocks are on fire, and for good reason.
The U.S. economy has far exceeded expectations at every phase of the recovery so far. The vaccines promise to end the remaining lockdowns and restrictions, or significantly curtail them. With the shackles removed, the economy will kick into high gear. Even several normally dour economists are predicting the highest GDP growth in decades this year.
For good measure, there will also be trillions in stimulus and still low interest rates. Real economy companies should see a massive rebound in profits. The market gets it. The Energy Select Sector SPDR Fund (XLE) has rallied a staggering 83% since the vaccine announcement in early November. And energy had been the worst performing market sector, by far, in every measurable period over the last ten years.
The Financial Sector SPDR Fund (XLF) is up 45% over the same period. And despite the recent rally, many financial stocks are still undervalued ahead of what should be an ideal environment for the sector.
Some companies don’t like rising interest rates. Financial companies love them. Rising longer-term rates enable banks and other lenders to get higher spreads on loans, as the Fed will likely keep short-term rates low. A booming economy combined with trillions of stimulus dollars floating around and still obscenely low interest rates will surely put upward pressure on rates. In fact, it’s already starting to happen.
These companies also tend to thrive in the early stages of an economic recovery. And many benefit from active markets. All these things seem sure to transpire as the year progresses. Within this thriving sector, there is a special opportunity.
In addition to the bright near-term prospects for financial stocks in general, there is also an incredible growth trend in the area of alternative investments. These include investments outside of the stock and bond markets. Individuals and institutions desperate to diversify are pilling in. And massive growth in this arena is accelerating.
In this issue, I highlight a company I believe to be the very best player in alternative investments. The stock’s performance has far exceeded its peers and there is every reason to believe the outperformance will continue going forward.
What to Do Now
This is a much different market than it was when last month’s issue came out on February 10th. The overdue selloff has finally arrived. But it’s not what most expected.
The technology-stock-heavy Nasdaq index officially fell into correction territory when it closed down 10.5% from the high on February 12th on Monday. But the S&P 500 is down less than 3% over the same timeframe. And it’s only down that much because of high exposure to technology shares. The Dow Jones is higher for the period.
The S&P 500 index doesn’t tell the whole story. Some stocks are highly priced while other are undervalued. It is the pricey part of the market that’s correcting, the other stocks are doing fine.
The Nasdaq index, with its high concentration in technology stocks, was up 43% in 2020 and over 100% since the lows of last March. It had been blowing away the other major market indexes this year too. That pace just couldn’t continue. Some sort of a selloff or consolidation was overdue. Maybe it’s done, maybe it’s not.
Meanwhile, the cyclical or open-up stocks are in a booming market of their own. The Financial Sector SPDR Fund (XLF) has been up 5.6% during the tech selloff and the Energy Select Sector SPDR Fund (XLE) is up 15%.
The S&P 500 hasn’t made much of a move because it’s housing a tug-of-war between the new winners and new losers. You can’t tell much looking at the performance of the S&P index itself. But a look under the hood shows a market very much in flux.
Where do we go from here?
Is the current dynamic spent, or does it have more to go? It’s difficult to tell if we should bet on the extension of moves that are getting mature, or set up for the next move. All the momentum is with the cyclical plays, and the tech selloff may not be done. On the other hand, cyclical stocks may be over extended and technology shares are getting cheap.
Fortunately, this isn’t a trading newsletter. The short term can be impossible to predict. But the rest of the year still looks strong with a full economic recovery, still-low interest rates, and trillions in stimulus. The promising year makes holding stocks for longer a better proposition. In the near term, we’ll hedge our bets.
We sold two thirds of the Qualcomm (QCOM) position already and are continuing to hold the remaining third. We also sold the remaining position in Innovative Industrial Partners (IIPR) last week and recently took partial profits in AbbVie (ABBV) and Eli Lilly (LLY) after those stocks had big up-moves.
We are still holding the big energy movers Valero Energy (VLO) and Chevron (CVX), but we aren’t buying any more at current prices. CVX is being reduced from a “BUY” to a “HOLD” in this issue. Broadcom (AVGO) has also sold off, but it’s still rated a “BUY.” That’s because AVGO is on stronger technical footing and just announced stellar earnings.
Of course, things can change fast. I’ll keep an eye on everything and let you know what changes are warranted going forward.
Featured SToCK
Buy KKR & Co. (KKR)
Alternative assets are basically those that do not fall within the realm of traditional stock and bond market investments. In the world of high finance, these assets include areas such as private equity and hedge funds among other things. Private equity includes investments of debt and equity stakes in companies that are not publicly traded or available to most investors. Alternative assets are a growth business for good reasons.
Consider your own investment situation. Bonds have become low paying and treacherous. You get very little return in today’s low interest rate environment while taking significant risk, as interest rates are likely to rise. That leaves just the stock market to fetch a decent return. Lately that’s worked out. But it’s risky to have a huge portion of your nest egg in the stock market.
This is an even bigger problem for high-net-worth individuals, and most especially for institutions like pension and endowment funds with fiduciary responsibility. They need to manage risk and diversify away from the market and get a decent return at the same time. Alternative assets are just what the doctor ordered.
KKR & Co. (KKR), Formerly Kohlberg Kravis Roberts Co., is a leading global alternative asset manager. The firm manages multiple alternative asset classes including private equity, energy, infrastructure, real estate, credit, as well as hedge funds through strategic partners. It generates revenues from management fees, performance income and investment income with a global reach on five continents.
As with any product that satisfies an otherwise unmet demand, alternative investments have been growing like crazy. The assets class has gone from the periphery in the early part of last decade to a major player in the investment industry.
By one well-sourced estimate, global alternative asset investments have grown from $6.4 trillion in 2012 to about $14 trillion in 2020. It is estimated that alternative assets worldwide will continue to grow to more than $21 trillion by 2025. Estimates vary of course. But all estimates show rapid growth.
There are several major publicly traded players in the alternative asset arena. Industry powerhouses include The Blackstone Group (BX), The Carlyle Group (CG) and Apollo Global Management (APO). Why pick KKR?
One reason is superior stock performance. KKR has blown away the performance of its peers in just about every measurable period over the past five years. Since its IPO on July 15, 2010, KKR has delivered an average annual return of 21% (with dividends reinvested). And performance has been even better more recently. KKR averaged returns of 32% per year over the last five years, 31% over the last three, and 62% over the past year.
The superior performance is well justified with a look under the hood. Assets under management (AUM), a hugely important determinant of revenues, grew at a compound annual growth rate (CAGR) of 22% since 2012. Annual fee business, which adds predictability, has grown at a CAGR of 15% since 2016. Earnings per share grew at an average rate of more than 14% per year over the past five years.
The firm seems to know what it’s doing. It had a stellar year in pandemic-stricken 2020. The investment portfolio had minimal investments in the most hard-hit sectors in the first nine months of the year: 3% in Hotels and Leisure, 3% in Energy and 3% in Retail. At the same time, the largest allocations, 21% overall, were in Information Technology. KKR’s flagship private equity funds returned an average of 32% in 2020. And fee-related earnings soared 59% for the year.
Of course, what matters now is where KKR is going in the future. There are some very positive signs. It had an all-time record fundraising year in 2020, bringing in $44 billion in assets under management for the year. A record $12.5 billion was deployed, or invested, in the fourth quarter. And the firm still has plenty of dry powder going forward.
KKR also made a huge $4.4 billion investment acquiring Global Atlantic Financial Group, a huge player in the insurance industry. It further diversifies KKR into this timely industry and Global’s growth has been even more impressive than KKR’s in recent years. It grew assets from $17 billion to $90 billion between 2013 and 2019, a CAGR of 29%. It also grew adjusted operating earnings by a 17% CAGR and book value by 16% over the same period. The acquisition could be a needle-mover going forward.
As I mentioned above, financial stocks are relatively cheap. Despite the recent stellar performance, KKR still sells at a price/earnings ratio of less than 14 times. That’s well below the five-year average and less than half of the current S&P 500 price earnings ratio.
KKR also pays a quarterly dividend with a current 1.23% yield. That’s not much. But with a payout ratio of just around 20%, there is plenty of room for payout growth going forward.
KKR & Co. Inc. (KKR)
Security type: Common stock
Category: Finance, Asset Management
Price: $47.08
52-week range: $15.55 - $49.29
Yield: 1.23%
Profile: KKR is a leading global alternative asset firm that manages multiple asset classes, including private equity, credit and real estate assets, and hedge funds managed with strategic partners.
Positives
- Financial sector stocks should continue to thrive in a full recovery later this year.
- KKR has consistently and significantly outperformed its peers in the industry.
- Alternative assets management is a rapidly growing industry.
Risks
- Investment markets are highly unpredictable.
- This is not a good down-market stock or asset class.
Portfolio at a Glance
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Portfolio Updates
February 10th
Purchased Chevron Corp. (CVX) $92.52
February 24th
NextEra Energy (NEE) – raised rating from “HOLD” to “BUY”
STAG Industrial (STAG) – raised rating from “HOLD” to “BUY”
Valero Energy (VLO) – lowered rating from “BUY” to “HOLD”
Altria (MO) – moved from Dividend Growth tier to High Yield Tier
Brookfield Infra. (BIP) – moved from High-Yield Tier to Dividend Growth tier
Realty Income (O) – moved from Dividend Growth Tier to High Yield Tier
March 3rd
Sold Innovative Industrial Properties (IIPR) $187.77 – Total return 168%
Sold 1/3 Qualcomm (QCOM) $131.66 – Total return 61%
March 10th
Buy KKR & Co. (KKR)
Chevron (CVX) – lower rating from “BUY” to “HOLD”
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 – 7.6%) – Last week I mentioned that MO has been looking good and that it may be breaking the downtrend that has been in place since 2017. Now, I’m starting to believe it. It’s up 14% since February 1st and 28% since November 1st. That’s a sizable move for this normally slow-moving income stock. First, it stopped going down more. Then, it started making a series of new post-pandemic highs.
It had been a solid income stock in the present, but the market factored in zero chance of replacing slipping cigarette sales with other revenue over time. That may be overly pessimistic. It has a joint venture to market heated tobacco product IQOS with Philip Morris International (PM), exposure to marijuana with its stake in Cronos (CRON) and possibly a lot more revenue than currently expected in the e-cigarette business. BUY
Enterprise Product Partners (EPD – yield 7.8%) – This midstream energy partnership is clearly trending higher, albeit at a slower pace than most of its energy sector peers. Business won’t rebound as dramatically in a full recovery because it didn’t contract nearly as much as its peers during the pandemic. But things are clearly going the right way. Meanwhile, EPD is still extremely cheap, and that massive yield is rock solid. It should provide high income along with capital appreciation over the course of this year. BUY
Realty Income (O – 4.7%) – Okay, this legendary income REIT took it on the chin unjustifiably as the market punished retail properties during the lockdowns. But the market is changing its stripes. And the new stripes don’t like Realty Income either. The REIT has raised the monthly payout every year since 1969. It also managed to grow funds from operations 9.9% in pandemic-stricken 2020. Maybe it’s just not exciting enough for investors in this market. We’ll see if they wise up eventually. BUY
STAG Industrial (STAG – 4.5%) – While STAG has vastly outperformed the REIT Index since the pandemic, the sector has had a rough time. It lagged the market during the recovery and then didn’t get the bounce that cyclical stocks got after the vaccine announcement. But the poor performance is creating value at a time when investment income is hard to get. STAG is a more cyclical REIT and should be among the first to rebound. The value and the timing are the main reasons the stock was upgraded a couple of weeks ago. BUY
Verizon Communications (VZ – 4.5%) – I get it. This stock has been lame. VZ has bounced around and gone nowhere during an epic bull market. It behaves like an old-fashioned utility with a decent yield and little else. But there are a couple of reasons this stock may be worth owning right now. It’s still at a lower point in the recent range and it’s also a good down-market performer at a time when the market is topsy. Plus, it stands to ratchet up earnings as the 5G rollout creates more opportunities in both the short and long term. 5G could also become a bigger market driver after the pandemic. 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 – 4.9%) – This biopharmaceutical stock is one of the best big healthcare companies on the market with a phenomenal pipeline at a time when the population is aging fast. But let’s talk stock performance here. A cynic might point out that the stock has gone sideways since November. But it’s gone sideways at a time when the healthcare sector has been stinking up the place and going nowhere. ABBV also soared 40% between late October and early January. The stock is also breaking the recent pattern of pulling back after a surge. It’s hanging tough at the higher level. It may be forming a base ahead of another move higher later. HOLD
Broadcom Inc. (AVGO – yield 2.9%) – Even this normally steady climber is getting hit by the selloff in the technology sector. It’s down 14% in March alone (as of the closing price on Monday). And the fall came after the company reported stellar earnings that beat expectations. Broadcom posted 26% earnings per share growth and 14% revenue growth versus last year’s quarter. The company also guided to better-than-expected earnings for next quarter. But sector selloffs tend to drag everything down. Despite being up 60% over the past year, Broadcom still sells at a reasonable level of 15 times forward earnings. I consider the recent selloff to be a buying opportunity. BUY
Brookfield Infrastructure Partners (BIP – yield 4.0%) – The infrastructure partnership is well positioned for the rest of the year despite going sideways lately. It’s been a great market for cyclical stocks while many other stocks and sectors are just sort of treading water. The focus on open-up plays has left BIP in the buy range ahead of a promising year. Earnings should be headed higher as new projects come online and transportation and energy assets regain traction. It’s also true that infrastructure is an increasingly popular sector, and it could get a further boost as it becomes a focus of the new Administration in Washington. BUY
Rating change “BUY” to “HOLD”
Chevron Corp. (CVX – yield 5.2%) – This best-in-class energy major is still red hot. It’s up about 30% since the end of January and the ascent seems to continue every day. CVX is also up 55% since the vaccine announcement. That’s a huge move in a short time for this stock.
It’s still below the pre-pandemic level of around 120 per share. Of course, the environment for the rest of the year could be better than that one. I’m not sure how far the stock will go on this surge or how long the market energy bender will last. If you own it already, by all means hang on to it. But this no longer appears to be an ideal entry point. HOLD
Digital Realty Trust (DLR – yield 3.5%) – This data center REIT is stinking up the place so badly it’s even been underperforming the REIT index, which is not exactly lighting the market on fire of late. The market is really giving this pandemic beneficiary the cold shoulder during this cyclical stock bender. But the positive story is still intact. The growing number of connected devices and demand for technology infrastructure is rising steeply. DLR historically doesn’t wallow like this for very long and the recent weakness in the stock should be a buying opportunity. BUY
Eli Lilly and Company (LLY – yield 1.7%) – After a huge 70% upside surge in two months, this big pharma stock has hung tough not far from the recent high. Historically, LLY has pulled back after such a surge. But, like ABBV, it could be forming a new base at a higher level. It’s still priced a little on the high side now, but for good reason. The company has enjoyed a plethora of good news including better-than-expected earnings, higher guidance, and fantastic news from its pipeline drugs. I love the stock for the longer term. HOLD
Qualcomm Inc. (QCOM – yield 2.1%) – This stock got a one-two punch. First, although earnings beat expectations, the company announced slower than expected iPhone sales because of industry supply issues that will last through the first half of the year. That was too much reality for a high-flying stock. The stock pulled back after earnings and then got hit with the sector selloff in technology. It’s down 25% from the early February highs as of Monday’s close.
This newsletter has already taken profits on two thirds of the position. The stock is well positioned going forward as the 5G rollout will boost earnings beyond recent levels. Although there could be further downside in the near term, the remaining position is worth holding ahead of a promising year. HOLD
U.S. Bancorp (USB – 3.3%) – It is an increasingly friendly environment for banks. A full recovery looms in the months ahead and interest rates are on the rise. That makes for higher loan demand and increasing interest rate spreads and profits. That’s why banks have been on fire. The SPDR S&P Bank ETF (KBE) is up 25% since the end of January. At the same time, many banks are still relatively cheap after taking it on the chin during the pandemic. USB is still well below the pre-pandemic price with room to run. The environment ahead is shaping up to be better than it was pre-pandemic. BUY
Valero Energy Corp. (VLO yield 5.0%) – Volatility is a beautiful thing when it goes the right way. VLO is on fire. It’s up 40% just since late January and well over 100% since the vaccine announcement in November. How high will it continue to surge? It’s hard to tell when this latest move runs out of gas. But regardless of what happens in the near term, I like it for the rest of the year. Demand for gasoline and diesel will skyrocket in a full recovery. And VLO is still a long way from the pre-pandemic price. And things weren’t great then. 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 Bullet Shares 2021 Corporate Bond ETF (BSCL – yield 2.0%) – Bonds have gotten roughed-up lately as interest rates have risen sharply. But you wouldn’t know it owning BSCL. Short-term bonds are far less affected by changing interest rates and this ETF barely budged. This short-term bond fund is a safe port. It’s nice to have something in the portfolio that you don’t have to worry about. BUY
Invesco Preferred ETF (PGX – yield 5.1%) – 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, and it hasn’t been affected by the recent bond market volatility. It’s a great place to generate a solid yield while rounding out your portfolio. HOLD
NextEra Energy (NEE – yield 2.2%) – Normally an up-trending juggernaut, the alternative energy utility just had a nasty 20% pullback from the high of late January. There doesn’t seem to be any news at the company itself. The market has been shunning safer plays and utility stocks amidst the recent cyclical stock rally. As a high-flying utility, NEE is taking it on the chin as the sector falls from favor. I think this represent a rare buying opportunity ahead of very promising days for alternative energy stocks as the new Administration puts more focus on clean energy. BUY
Xcel Energy (XEL – yield 3.0%) – The same thing I said about NEE is true of this smaller alternative energy utility, except the stock has fallen further and longer from the high. It also has more upside potential in a short amount of time when things turn around. A conservative play on a fast-growing trend won’t go out of style for long. This is an excellent time to get into what should be a terrific longer-term play. The company also just raised the dividend by 6.4%. BUY
Something Else about Financial Stocks
Sure, the rest of the year looks great for financial stocks. But the secular trend could be even better.
Financial stocks had a terrible bull market last time. These companies were ground zero in the financial crisis, and the sector took a bloodbath for the ages. After the financial crisis, companies slashed dividends, were pelted with new regulations from Washington, and got scorned by investors for a long time.
This should give you an idea of what a crummy bull market these companies had last time around. The S&P 500 eclipsed the pre financial crisis high in 2013. The XLF just eclipsed the pre financial crisis high last month. The SPDR S&P Bank ETF (KBE) still hasn’t gotten back to the highs of 2007.
Previous bull markets had been much, much better for financial stocks. Banks and large financial companies had been among the best dividend stocks to own in decades past. The stench from the financial crisis has faded. These stocks should be a much hotter ticket in this bull market. And we’re still in the very early phases.
Financial stocks offer value and momentum for the near term. But they should also offer much better returns than they did over the past decade in the next decade.
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 April 14, 2021.
Cabot Wealth Network
Publishing independent investment advice since 1970.
President & CEO: Ed Coburn
Chairman & Chief Investment Strategist: Timothy Lutts
176 North Street, PO Box 2049, Salem, MA 01970 USA
800-326-8826 | support@cabotwealth.com | CabotWealth.com
Copyright © 2021. All rights reserved. Copying or electronic transmission of this information is a violation of copyright law. For the protection of our subscribers, copyright violations will result in immediate termination of all subscriptions without refund. No Conflicts: Cabot Wealth Network exists to serve you, our readers. We derive 100% of our revenue, or close to it, from selling subscriptions to its publications. Neither Cabot Wealth Network nor our employees are compensated in any way by the companies whose stocks we recommend or providers of associated financial services. Disclaimer: Sources of information are believed to be reliable but they are not guaranteed to be complete or error-free. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. Buy/Sell Recommendations: All recommendations are made in regular issues or email alerts or updates and posted on the private subscriber web page. Performance: The performance of this portfolio is determined using the midpoint of the high and low on the day following the recommendation. Cabot’s policy is to sell any stock that shows a loss of 20% in a bull market or 15% in a bear market from the original purchase price, calculated using the current closing price. Subscribers should apply loss limits based on their own personal purchase prices.