June 7, 2023

It’s Not Time to Give Up on Defense

This is, dare I say, a good market.

The S&P 500 is up 11.31% YTD, and the year isn’t even half over. Stocks have rallied more than 20% from the October low. The index is within bad breath distance of last summer’s high. The S&P is only 10% below the all-time high.

Why is the market so strong? There are several reasons. Inflation is coming down. The Fed is almost done hiking rates. And there is no recession. Throw in a booming artificial intelligence business and you have a rising market.

But this market is lopsided. Technology is booming but practically every other sector is down for the year. The FAANG stocks comprise about 25% of the S&P 500 index and they are soaring. The information technology sector is up over 35% YTD. But without that sector, the market is laying an egg.

Technology is on a different schedule than the overall market. The sector fell before most other stocks last year and now it is recovering before the rest of the market this year. Technology plunged last year as inflation and interest rates rose and it’s soaring this year as those things are abating. The AI craze recently gave the rally a shot of adrenaline.

We’ll see how much longer technology can drive this market higher. In the meantime, defensive sectors like utilities, healthcare, consumer staples, and energy are having a crummy year. But things can change. It’s not time to give up on them while they are cheap ahead of a slowing economy amid an earnings recession.

Many of the portfolio positions are cheap ahead of a period that has historically been one of relative outperformance. This is just a snapshot in time. Things may look a lot different later in the year.

Recent Activity
May 10^th
Purchased Hess Corporation (HES) - $135.24

May 17^th
ONEOK, Inc. (OKE) - Rating change “BUY” to “HOLD”

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
Broadcom Inc. (AVGO) - Rating change “HOLD” to “SELL ½”

High Yield Tier

Enterprise Product Partners (EPD – yield 7.6%) – Enterprise is slowly and quietly getting the job of a high-income security done. It returned 15% last year and 12% 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. The company has just a 55% payout ratio and the distribution is covered 1.8 times by cash flow. That’s sky-high for the industry. (This security generates a K1 form at tax time). BUY

ONEOK Inc. (OKE – yield 6.7%) – The stock has stabilized and even moved a little higher since the market hated its announced acquisition 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 market doesn’t seem to like it because the benefits are primarily longer-term. The deal could negatively affect numbers in the near term. The dividend is safe. The stock is recession and inflation resistant. And the longer-term prognosis is good. HOLD

Realty Income (O – yield 5.1%) – This year so far has been a tough one for defensive stocks and REITs. Although the YTD return is -3.42%, it isn’t time to give up on the stock. This market rally might be 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. HOLD

The Williams Companies, Inc. (WMB – yield 6.2%) – It’s been a crummy year so far for this midstream energy company stock. It’s down over 7% YTD. This year has not been kind to defensive stocks or energy stocks so far. There’s also natural gas. Prices have fallen largely because of the unusually warm winter temperatures throughout the country and the world. But that’s a temporary issue that isn’t affecting earnings. Williams once again delivered 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. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 4.4%) – ABBV has crashed. The stock has fallen 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. The stock could fly again once investors start looking past this year. BUY

Broadcom Inc. (AVGO – yield 2.3%) – This is by far the best-performing portfolio stock so far this year, up 44%. Performance also hasn’t been too shabby since it was added to the portfolio in early 2021, despite recent troubles in the technology sector. It is a primary beneficiary of the AI craze and previous earnings projections are probably way too low. The stock is off the high, but the 52-week high reflects a hysterical one-day run-up. AVGO has been hanging tough at a much high level after the surge. The portfolio sold half the position last week as there is a possibility of a pullback in an unpredictable market. HOLD

Brookfield Infrastructure Partners (BIP – yield 4.2%) – The infrastructure company is up over 5% since the beginning of May while the market is only up 2.5% over the same period. 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. It is around the top of the recent range, and it’s well-positioned for the months ahead. (This security generates a K1 form at tax time). BUY

Eli Lilly and Company (LLY – yield 1.0%) – This is another star portfolio performer that has returned 50% in the last year and over 200% since being added to the portfolio less than three years ago while the S&P 500 has returned just 32% over the same period. The pharma superstar has two potential mega-blockbuster drugs up for approval later this year or early next as well as solidly growing earnings for the foreseeable future. But the stock tends to pull back after big surges and half of the position was sold to lock in some of the recent profits in an uncertain market. But LLY is hanging tough so far. HOLD

Hess Corporation (HES – yield 1.3%) – This energy exploration and production company got a bit of a boost after Saudi Arabia announce another million barrels per day in production cuts, adding to a plethora of factors that will pressure oil prices higher 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. BUY

Intel Corporation (INTC – yield 1.8%) – After Nvidia (NVDA) rocked the market with blowout earnings, Intel appeared to get yet another black eye. INTC fell 7% on the day of the announcement because it doesn’t really have a competitive AI chip. There’s one in the works. But it isn’t expected to launch until 2025.

But INTC got new life and soared 13% over the next week as the Nvidia CEO expressed interest in using Intel’s production facilities for its chips. Intel has greatly expanded its foundry business and can benefit from the AI frenzy in another way. INTC pulled back Monday but is up again on Tuesday after announcing the sale of $1.5 billion of Mobileye (MBLY) to raise cash. HOLD

Qualcomm Inc. (QCOM – yield 2.8%) – Qualcomm is definitely benefitting from the AI excitement of the last ten days. It’s up over 14% since the Nvidia report. Qualcomm describes itself as the “on-device AI leader,” as opposed to Nvidia’s data center chips. The company will surely benefit as investment and profits from AI are now likely to soar sooner than previously expected. The company had been reeling from falling smartphone demand. But recent developments indicate that profits are likely to rise sooner. HOLD

UnitedHealth Group Inc. (UNH – yield 1.3%) – UnitedHealth has strong predictable revenues in a very defensive business ahead of a possible recession later this year or early next. UNH has been a terrific stock to own in any market, as its three-, five- and ten-year returns attest. But it is also the epitome of a stock to own during an economic downturn. It pulled back since being added to the portfolio, but the lagging in defensive stocks is likely to correct itself in the months ahead. 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 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 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. 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 5.8%) – After pulling back in unjustified sympathy with the overall bank selloff, this preferred issue is marching 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 6.2%) – 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 things escalate into a more widescale problem. BUY

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.4) – 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