June 21, 2023

The Rally Teeters

The impressive rally that has confounded so many may be running out of gas.

As of Friday’s close, the S&P 500 is up about 15% YTD and over 20% from the October low, making it officially a new bull market. Investors are optimistic that inflation is falling, the Fed is almost done hiking, and there is no recession in sight. The market is sensing that we can get through this rate-hiking cycle without much pain.

But this rally is not as impressive as it seems. Only about 10 large technology stocks account for just about all the YTD gains. The other 490 stocks on the index have collectively gone nowhere.

It’s also true that the economy is likely to slow, even if there isn’t a recession in the quarters ahead. It will be tough for stocks to build significantly on this rally under such circumstances.

Defensive stocks have been dogs so far this year. But that situation could be reversed. The rally will likely have to either broaden out or peter out. Either situation bodes well for the relative performance of defensive stocks.

A broader rally will likely include defensive sectors in an environment where overall earnings continue to contract. A stumbling rally should also benefit the defensive sectors as they will likely be the best place to be. The first half of the year is nearly over. And defensive stocks look like good positioning ahead of the second half.

Of course, anything is possible, as the first half of this year exemplifies. And technology is on its own schedule as many companies will grow strongly even in a bad economy. The portfolio still has positions in Broadcom (AVGO), Qualcomm (QCOM), and Intel (INTC) that are benefiting in the current environment.

But sector performance tends to rotate. And history clearly shows that defensive stocks are stronger relative performers in a slowing economy.

Recent Activity

May 23^rd
SOLD ½ Eli Lilly and Company (LLY) - $423.21

May 31^st
AbbVie Inc. (ABBV) - Rating change “HOLD” to “BUY” and BUY 1/3
SOLD ½ Broadcom Inc. (AVGO) - $807.96

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

High Yield Tier

Enterprise Product Partners (EPD – yield 7.4%) – Enterprise is slowly and quietly getting the job of a high-income security done. It returned 15% last year and over 13% so far this year. The partnership also increased the quarterly distribution by 5.4%. Business is solid while most company earnings are shrinking. That massive payout is rock solid and growing. Enterprise should be a solid holding with a slowing economy ahead. (This security generates a K1 form at tax time). BUY

Rating change – “HOLD” to “BUY”

ONEOK Inc. (OKE – yield 6.3%) – OKE is continuing to bounce back admirably from the selloff of a couple of weeks ago when the market hated its purchase of Magellan Midstream Partners (MMP). 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 high and safe dividend and reliable earnings in an environment where overall market earnings are contracting. It appears that the post-merger announcement sell-off was overdone and the stock should be out of danger. BUY

Realty Income (O – yield 5.0%) – This year so far has been a tough one for defensive stocks and REITs. Although the YTD return is -1.22%, it isn’t time to give up on the stock. This market rally might run out of gas and there is still the possibility of recession later this year or early next year. Defensive stocks could make up for lost time in the next several months. This is a company with safe consumer staple tenants that has raised the dividend through the last three recessions. The stock is having a good June so far and the momentum may continue. HOLD

The Williams Companies, Inc. (WMB – yield 5.9%) – This year has not been kind to defensive stocks or energy stocks so far. Natural gas prices have fallen largely because of the unusually warm winter temperatures throughout the country and the world. But it isn’t affecting the bottom line. Williams once again delivered on earnings and beat expectations for the fourth straight quarter. Earnings per share grew a whopping 36% over last year’s quarter as natural gas volumes remained strong and growing. WMB has fallen after an early June spike, but it still looks encouraging. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 4.3%) – This has not been a good recent phase for the pharma powerhouse. The stock fell over 20% from the recent high to a brand-new 52-week low. This 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. Revenues will shrink this year and next. But that has long been known and the future is bright. 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. BUY

Broadcom Inc. (AVGO – yield 2.1%) – This semiconductor and software infrastructure stock continues to be hot stuff. It is riding the AI wave as a primary beneficiary of the increased investment in the emerging technology. AVGO is up 35% over the last month, 56% YTD, and 78% for the past year. Half of the position was sold when the stock leveled off after the initial AI spike. But it has since mustered another spike higher instead of pulling back. We still have half of the position, and we’ll see if it can maintain these price levels if the market gets dicey in the weeks ahead. HOLD

Brookfield Infrastructure Partners (BIP – yield 4.3%) – The infrastructure company stock has pulled back from the recent high, down over 4% over the last week. But BIPC 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. The stock had been suffering from the lull in defensive stocks, but it won’t stay down for long. A pullback from the recent spike higher is typical for this stock. But it is relatively cheap ahead of a promising second half of the year. (This security generates a K1 form at tax time). BUY

Eli Lilly and Company (LLY – yield 1.0%) – This is another superstar performer that is refusing to pull back after a huge surge. LLY is up over 36% in the last few months and has averaged an annual return of over 40% for the last three years. It’s no wonder. Lilly 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. The stock tends to pull back after big surges, which is why half the position was sold to protect profits. So far, LLY is hanging tough around the high. HOLD

Hess Corporation (HES – yield 1.3%) – This energy exploration and production company stock is riding a tug-o-war between the negative effects on oil prices in a slowing economy versus a plethora of factors putting upward pressure on oil prices in the months ahead. 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 1.4%) – INTC had initially stumbled after Nvidia (NVDA) rocked the market with blowout earnings. But it has made up for it since. The stock has surged over 30% since the day of the Nvidia report and 16% in just the last week. It’s mostly excitement regarding its expanding chip production capabilities. The Nvidia CEO expressed interest in partnering and the company is continuing to ink new deals around the world. INTC is being increasingly seen as a cheap stock with a bright future. HOLD

Qualcomm Inc. (QCOM – yield 2.6%) – QCOM continues to benefit as AI takes center stage. The stock was floundering because of lower smartphone demand. But it got new life. QCOM is up about 20% in less than a month and the momentum may continue. 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. Recent developments indicate that profits are likely to rise sooner and future prospects are better. HOLD

UnitedHealth Group Inc. (UNH – yield 1.6%) – It’s been a rough patch for UnitedHealth. The main problem was last week 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 out as 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 has been hanging so tough near the high end of the recent range despite a nowhere market. The payments processing company grew earnings per share by 17% and revenues grew double digits versus last year’s quarter. That’s terrific when the average stock is posting lower earnings. Plus, it can really take off when the market recovers for good. This is a great stock in an up market. The resilience in this market is encouraging and makes the stock easy to hold. 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 its 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 that could change in a big way if there is an economic recession or a continued 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. The stock has also come off the low and may have some momentum. 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 unjustified sympathy with the overall bank selloff, this preferred issue marched right back. 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 resume moving 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