March 1, 2023

As the Rally Fades, Look to Dividends

January was up. February was down. What’s next?

The S&P 500 rallied 6.2% in the first month of the year but pulled back 2.3% in February (as of Monday’s close). The market is still in positive territory YTD. But that could change.

The January optimism is being squelched by an upward tick in inflation to start the year and fears of more hawkishness from the Fed than previously expected. The cyclical rally has ended as investors sense that the same sticky inflation/aggressive Fed tango that drove stock prices lower last year will continue further into this year.

It is unlikely that stocks can muster sufficient traction to rally into the next bull market until investors can see past this cycle and into the next recovery. While that rally could ignite sometime later this year, we may be in for more choppiness for a while.

It’s important to realize the contribution of dividends in markets like this. Growth stocks have thrived over the past couple of decades in an environment of low inflation and low interest rates. But the relative performance of dividend stocks is better in times of inflation and higher rates.

Dividends have contributed about 40% of the S&P 500’s total return on average over the past 100 years or so. But those returns tend to be much higher during times of inflation. In the high inflation decades of the 1940s and 1970s, dividends contributed a staggering 67% and 73% of market returns, respectively.

Current Allocation
Stocks 32.5%
Fixed Income 20%
Cash 47.5%

High Yield Tier

Enterprise Product Partners (EPD – yield 7.6%) – The midstream energy partnership is quietly holding its own in a back and forth and uncertain market this year. EPD is returning a market-beating YTD 9% return after delivering a stellar 18.4% return in the 2022 bear market. The stock also recently broke out of the recent range to its highest price since late summer. EPD is also well positioned for inflation, a faltering economy, or both. (This security generates a K-1 form at tax time). BUY

ONEOK Inc. (OKE – yield 5.6%) – This midstream energy company once again reported strong earnings that beat expectations. Earnings per share soared a whopping 28% in the fourth quarter and 15% for the full year. Earnings reflected steady growth in natural gas pipelines and gathering and continued growth in the natural gas liquids segment, despite an overall slowdown in exports. But the stock is down 1.7% after the report. OKE had moved sharply higher from the October low but has been moving sideways for the past six weeks. OKE has been hanging tough and consolidating in this higher range though. BUY

Realty Income (O – yield 4.7%) – The legendary income REIT also delivered solid earnings with 6.4% growth for the quarter and 9.2% for the full year. But it has moved lower since the announcement due to the recently indiscriminate market. O has still been trending slowly higher since the middle of October. The REIT sector is having a much better year so far. O has delivered a positive return over the last year while the overall market is down. BUY

The Williams Companies, Inc. (WMB – yield 5.8%) – Williams reported solid earnings this week with 21% full year growth over 2021. The issue is that the company expects slower growth of just 3% in 2021 as the benefit of recent acquisitions draw tougher comparisons. But the dividend is rock solid with 2.37 times coverage from cash flow and future growth is likely to resume and a stronger clip in the years ahead. It also has an inflation- and recession-resistant business that should help it to outperform the market this year. BUY

Medical Properties Trust, Inc. (MPW – yield 11.2%) – After rallying on good news from a previously troubled tenant the prior week, MPW plunged 14% last week after the market didn’t like its fourth-quarter earnings report. While the company did beat expectations on both the top and bottom lines, investors didn’t like some of the information that came out of the report.

It’s tough to say specifically what spooked investors most or if it was just the negative totality. The company typically raises the first-quarter dividend, but it didn’t this time. They also indicated that higher interest rates will significantly slow the pace of acquisitions this year. And finally, they said that one of the issues with a tenant will take 12 to 18 months before MPT is made whole. The lack of growth is already reflected in the stock that sells at just 6 times cash flow. The stock will be closely monitored from here and kept in the portfolio for now. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 3.9%) – ABBV pulled back in January as the defensive stocks underperformed but has regrouped and is moving higher again in February. The choppier market has caused somewhat of a rotation back into defensive plays like healthcare. The near-term fortunes of ABBV will largely depend on how defensive stocks move after the end of the cyclical rally. Longer term, this stock is a winner. AbbVie has a phenomenal pipeline that can replace the lost Humira revenues in a relatively short time. HOLD

Broadcom Inc. (AVGO – yield 3.1%) – Despite dipping lower in February, this software and chip company goliath has been trending sharply higher since October. It made a very big move and was up over 40% from the low a couple of weeks ago. Its fortunes are tied to the technology sector, but it has done a lot better than its peers in the tough market. Broadcom reported a 34% earnings increase in the last quarter. It reports the most recent quarter on Thursday. Hopefully it gets a bump. HOLD

Brookfield Infrastructure Partners (BIP – yield 4.5%) – The infrastructure juggernaut has been very bouncy over the last two years. It was hit along with everything else by covid as its transportation assets suffered. Lately, it has been hurt by the strong dollar and higher interest rates as the company does a lot of business overseas and has a relatively high credit balance. But it still has very resilient earnings, a great track record, and a safe dividend. (This security generates a K-1 form at tax time). BUY

Eli Lilly and Company (LLY – yield 1.3%) – LLY is down 7% in the past month and over 13% YTD after a stellar 2022 where it returned 34% in a bear market. This is not inconsistent with the historical pattern of the stock, where it tends to pull back after a surge. But LLY has returned more than 900% over the last 10 years despite ups and downs. It should continue higher over the longer term because it is expected to grow earnings by 19% on average over the next five years and it has two potential mega-blockbuster drugs that could be approved in the next year. HOLD

Intel Corporation (INTC – yield 2.0%) – Last week, Intel announced that it is cutting the dividend by 66%. The move was unexpected as the company seemed to indicate otherwise in the latest earnings report. It was also a low payout ratio until the recent earnings plunge as a result of falling PC sales. The cut knocks the yield from roughly 5.5% to 2%. While many might argue in favor of feeding cash flow, it effectively ruins the only thing this stock had going for it over the past few years.

The good news is that the stock didn’t really fall much after the announcement. The price is so low already there wasn’t much left to punish. It indicates that perhaps the stock has already bottomed out. Intel is still a powerful industry player and its recent attempts to catch up to its competitors should succeed to a least some degree over time. Meanwhile, the stock sells at a fire-sale price at just about book value. The portfolio will hold on for now in case it recovers somewhat in the days and weeks ahead. HOLD

Qualcomm Inc. (QCOM – yield 2.4%) – It’s been a rough market for QCOM. The stock is down over 26% for the last one-year period. But the longer-term prognosis remains bright and the stock is also showing signs of having perhaps bottomed out. Qualcomm reported lousy earnings for the last quarter, and it appears that next quarter won’t be much better. Yet the stock remained quite resilient after the report and is still up 12% YTD. That suggests that this news was already factored into the stock price, and the market is looking towards improvement in the second half of the year. HOLD

Visa Inc. (V – yield 0.8%) – The payments processing company stock has been thriving. After an impressive -3.4% return in last year’s bear market, V is up over 6% YTD. Even if the recent cyclical reversal continues, V should continue to hold up relatively well and it is giving a preview of how well it will react when the market finally turns for good. It’s well worth holding through the uncertainty into the next recovery. HOLD

Safe Income Tier

NextEra Energy (NEE – yield 2.6%) – This combination regulated and clean energy utility had been hanging tough in the January rally as other defensive stocks lagged. But the resilient behavior ended and NEE has fallen 17% in the last six weeks. Earnings were stellar and there doesn’t appear to be a company-specific reason for the recent selling. It appears that the market just made up for lost time quickly. The stock is at the low point of the recent range ahead of a period where defensive stocks could thrive. BUY

Xcel Energy (XEL – yield 2.8%) – This clean energy utility stock fell in the earlier part of the year but has held steady since. XEL is still very well positioned ahead of a slower economy but it appears to have broken through some near-term resistance and could move lower. I don’t believe defensive stocks are through yet and stocks like XEL are now cheaper. It’s also true that this clean energy utility is also capable of performing very well in a market recovery. HOLD

USB Depository Shares (USB-PS – yield 5.6%) – This preferred stock was added to the portfolio when interest rates were near the high, so it has returned more than 10% since. But interest rates have been moving back higher as economic strength and a hawkish Fed weigh on the fixed income market. But rates are still high relative to where they are likely to be longer term. BUY

Invesco Preferred ETF (PGX – yield 5.6%) – Ditto what I said about USB-PS. Longer-term rates have moved back up to the highest level since November. It’s still unclear if they will continue to move higher or if this is just a temporary bounce. But it is still a good time to buy this preferred ETF and the stable income provides a cushion in tough markets and rates may come down again. BUY

Vanguard Long-Term Corp. Bd. Index Fd. (VCLT – yield 4.1%) – There could be some near-term turbulence with the price on the way to solid longer-term returns and diversification. An imminent recession is out the window and there may be a period of rising rates again before the economy stalls out later in the year. BUY