July 6, 2023

Act Two of 2023 Begins

The S&P 500 delivered an impressive 16% return in the first half. Can the good times continue in the second half?

A big part of the latest surge higher has been the artificial intelligence (AI) excitement. After Nvidia (NVDA) blew away expectations citing far greater demand for AI technology, the market-leading tech sector caught fire. But returns were impressive even before then as the market is sensing a soft landing.

Inflation is falling. The Fed is at least almost done hiking rates. And there is no recession is sight. Recent numbers indicate the economy is much stronger than expected. It looks like we might get through this steep rate hiking cycle with minimal economic pain.

True, it has been an incredibly thin rally with only about 10 large-cap tech stocks accounting for almost all the YTD gains. But the rally broadened out over the month of June. Perhaps that’s a portent of things to come.

The market has confounded most pundits who expected a rather ugly first half with a recovery in the second half. With market expectations distinctly more positive, it would be very much like the market to flip the script and deliver a rotten second half. Of course, that’s just cynical speculation. A good first half of the year is historically most often followed by a solid second half.

There are risks though. Even if the economy isn’t slowing, the Fed may have to raise rates until it does slow down. A 25% rally from the October low may not have much further to go in a slowing economy. But we’ll see what happens.

The portfolio has a combination of the more growth-oriented and cyclical stocks that will benefit if the good times continue as well as defensive stocks that have largely been moving higher in the broadening rally. Those stocks should also outperform if the market goes sideways or down from here.

Recent Activity

June 21
ONEOK Inc. - Rating change “HOLD” to “BUY”

June 28
Realty Income – Rating change “HOLD” to “BUY”

High Yield Tier

Enterprise Product Partners (EPD – yield 7.5%) – Enterprise is getting the job done while paying a massive yield that is rock solid. EPD has returned over 14% YTD despite being in a sector that hasn’t participated in this market rally. It’s also not far from the 52-week high and may be headed for a breakout. The partnership also increased the quarterly distribution by 5.4%. Business is solid while most company earnings are shrinking. Enterprise should be a solid holding in a broadening or changing rally. (This security generates a K-1 form at tax time). BUY

ONEOK Inc. (OKE – yield 6.5%) – After getting clobbered last month when the market hated its purchase of Magellan Midstream Partners (MMP), OKE has been soaring right back and has regained nearly all of those losses. The deal will turn ONEOK from a natural gas operator to a diversified midstream company that services oil and refined products as well. The deal is a longer-term positive that could hurt performance in the near term. But this will remain a solid performer with a high and safe dividend and reliable earnings in an environment where overall market earnings are contracting. HOLD

Realty Income (O – yield 5.1%) – In a tough market for both defensive stocks and real estate, O has been floundering. It still sells well below the pre-pandemic high, despite having higher earnings, and the stock has been moving up from near the lowest point since last summer. The second half should be better. Either investors will crave defense again or the rally will broaden out to include this year’s lagging sectors. BUY

The Williams Companies, Inc. (WMB – yield 5.6%) – This had been a tough year for defensive stocks and energy stocks. But the broadening rally is lifting WMB. The stock is up over 14% since the beginning of June. And the momentum could last. WMB is still well off the 52-week high, and earnings have been growing strongly. Earnings per share grew a whopping 36% over last year’s quarter as natural gas volumes remained strong and growing. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 4.4%) – This has not been a good recent phase for the pharma powerhouse. The stock fell from the recent high to a new 52-week low. And it continues to flounder. ABBV is a notoriously bouncy stock and the downward move started with disappointing earnings where its new drugs grew below projections in the long-awaited Humira patent expiration year. Eli Lilly had a similar issue years ago. The company has a phenomenal pipeline capable of replacing lost Humira revenues in the next couple of years. The stock is cheap and defensive and has a great future. BUY

Broadcom Inc. (AVGO – yield 2.1%) – I expected this stalwart and big AI beneficiary to pull back after the massive surge in May as this phase of the AI frenzy wore off. But AVGO had another surge higher in June and it is hanging tough near the high point of the recent much higher range. The AVGO return now exceeds 100% since being added to the portfolio in early 2021. It is no doubt a great company and returns should be good over the next couple of years. The road higher may not be as bumpy as expected. HOLD

Brookfield Infrastructure Partners (BIP – yield 4.3%) – The infrastructure company stock has pulled back from the recent high and was down in June. But BIP is still around the higher levels of the recent range. The stock got new life after a sluggish period because Brookfield reported a solid earnings quarter with funds from operations (FFOs) per share growth of 12.5% over last year’s quarter. BIP is still reasonably priced with a good dividend ahead of a promising second half of the year. (This security generates a K-1 form at tax time). BUY

Eli Lilly and Company (LLY – yield 1.0%) – A pullback after the huge surge higher this spring would be historically normal behavior for this stock. But it isn’t happening. LLY has trended slowly higher instead of pulling back. LLY has now returned over 200% since being added to the portfolio a little less than three years ago. The market has refused to cool on LLY because it has two potential mega-blockbuster drugs up for approval later this year or early next as well as better than 20% annual earnings growth for the next several years. HOLD

Hess Corporation (HES – yield 1.3%) – HES keeps bouncing around in the near term on positive and negative news about energy prices. The more resilient economy is a plus as are a plethora of factors likely to put upward pressure on prices in the intermediate term. The longer-term supply/demand dynamic favors energy very much and Hess is a special case. It can increase production almost at will with very low-cost production. It should be stellar if energy stocks move higher again. But the stock is also uniquely equipped to deal with short-term turbulence in the industry. BUY

Intel Corporation (INTC – yield 1.5%) – INTC pulled back sharply last week after soaring in the earlier part of June. The stock had surged over 30% in just a couple of weeks after Nvidia (NVDA) rocked the market with blowout earnings mostly from excitement regarding its expanding chip production capabilities. Intel is continuing to ink new deals around the world. INTC is still at the highest level since last summer and is increasingly being seen as a cheap stock with a bright future. HOLD

Qualcomm Inc. (QCOM – yield 2.7%) – Like INTC, QCOM has pulled back in the last couple of weeks after its initial AI surge. It’s bouncing around as investors fluctuate between confidence in the company’s future and waning AI excitement. Qualcomm describes itself as the “on-device AI leader,” and the company should benefit mightily from the increasing shift towards AI and profits are now likely to soar sooner than previously expected. HOLD

UnitedHealth Group Inc. (UNH – yield 1.4%) – It’s been a rough patch for UnitedHealth. The main problem was last month when the healthcare insurer reported rising costs as elective procedures are surging from pent-up pandemic-era demand. It’s a blip that will likely put a dent in earnings for the next couple of quarters. But it shouldn’t change the positive longer-term story. Plus, the rise in procedures may peter if the economy slows down. This is still a great stock to own in a highly uncertain environment. And now it’s cheaper. BUY

Visa Inc. (V – yield 0.8%) – V loves the surprisingly strong economy and increasing soft-landing talk. Inflation is down, GDP was revised higher, and the consumer is still strong. In addition, Visa just purchased a Brazilian fintech company that rival MasterCard (MA) also wanted and beat them out. As a result, V soared to a new 52-week high and the highest price in about two years. The stock has broken out to a new level and may have further to run. HOLD

Safe Income Tier

NextEra Energy (NEE – yield 2.5%) – This combination regulated and clean energy utility stock is currently at the lower end of that range. It is still more than 20% below the 52-week high. It has not been a good year for defensive stocks and the price is reflecting that. But the rally has broadened in the last month and there is an earnings recession. This company is targeting earnings per share growth of 6% to 8% annually through 2026 and 10% per year dividend growth through at least 2024. BUY

Xcel Energy (XEL – yield 3.3%) – This clean energy utility stock has been trending lower since the beginning of April and still flounders. Although this stock tends to be bouncy, the recent weakness doesn’t make much sense. Defensive stocks are still a safe and promising place to be as the economy slows and overall market earnings continue to fall. This stock has become cheap ahead of a period of likely market outperformance. BUY

USB Depository Shares (USB-PS – yield 5.9%) – After pulling back in sympathy with the overall bank selloff, this preferred issue has trended higher. This is a preferred stock of one of the country’s largest banks that has rising deposits. The bank is rock solid, and this security should continue to move according to interest rates. BUY

Invesco Preferred ETF (PGX – yield 6.4%) – Longer-term rates are bouncing around again with a bias toward lower since the bank failures increased the risk of recession later this year. This fund is also vulnerable to fluctuations resulting from banking troubles and many preferred issues are those of banks. The fund is only threatened if banking issues reemerge and escalate into a more widescale problem. BUY

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.5%) – There could be some near-term turbulence with the price on the way to solid longer-term returns and diversification. The increased risk of a recession this year bodes well for the near-term total return of this fund. BUY