March 15, 2023

The Fed Expectation Rollercoaster

After moving higher in January, stocks fell back again in February. After falling last week, stocks are sharply higher this week. Why can’t the market seem to make up its mind?

The main catalyst for the market so far this year is the perception of the inflation/Fed situation. When investors sense inflation falling and the Fed is almost done hiking rates, stocks rally. When they believe inflation is remaining sticky and the Fed will have to remain aggressive for a lot longer, stocks fall. This dynamic has been on full display in the last few trading days.

Last week, stocks plunged after the Fed commented that it will have to hike rates more and leave them higher for longer than previously expected. But the story has completely changed this week. Now, investors believe the Fed may be almost done hiking rates. What changed?

The Silicon Valley Bank failure changed the perception. A major part of the problem was that the bank had used the spike in deposits during the pandemic to buy Treasury bonds, which then had the worst year ever in 2022. It had to sell securities at a loss to meet withdrawals. There is more to the failure than that. But this is the Fed’s culpability in the problem.

Investors expect this bank failure crisis to temper the Fed. To this point, the Fed had seen minimal economic consequence of the steepest rate hiking cycle in 15 years and was emboldened to remain aggressive. But there is a lag time before the effects of the rate hikes ripple through the economy. Now stuff is starting to break. The Fed may want to pull back to analyze the damage already inflicted before raising rates more.

Then, February inflation came in as expected with CPI inflation falling to 6%, down from 6.4% in January and 9.1% at the peak last June. As a result of the bank failures and the “as expected” reduction in headline inflation, investors are back to the Fed is almost done mentality. In fact, the rate hike expectations for the Fed’s meeting next week have fallen from 0.50% to 0.25% with a minority even predicting no rate hike.

We will get a better idea of what the Fed really thinks next week after the rate hike announcement and follow-up statements. Also, it appears that there won’t be enough contagion to other banks to constitute a crisis, at least at this point. But, as evidenced by the past few days, things can change a lot in a week.

Recent Activity

March 8^th
Medical Properties Trust (MPW) – Rating change “BUY” to “HOLD”
Eli Lilly and Company (LLY) – Rating change “HOLD” to “BUY”
Xcel Energy Inc. (XEL) – Rating change “HOLD” to “BUY”
Visa Inc. (V) – Rating change “HOLD” to “BUY”

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

High Yield Tier

Enterprise Product Partners (EPD – yield 7.6%) – This midstream energy partnership isn’t very exciting but it’s working. It’s been a crummy market since the beginning of last year. But EPD has continued paying its robust distribution. EPD also returned 18.4% in 2022 when the S&P was down 19.4% for the year. It has also returned about 10% so far this year, including Tuesday’s rally. The partnership also has very resilient and inflation-protected earnings while most stocks are likely to experience an earnings recession in the quarters ahead. (This security generates a K1 form at tax time). BUY

ONEOK Inc. (OKE – yield 5.8%) – 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. But the stock has been going sideways to slightly lower for the past two months. It’s forming a solid base at this level and should benefit from growing earnings as that becomes increasingly rare in the market. BUY

Realty Income (O – yield 4.8%) – In a rudderless and directionless market, income is king. And this legendary income REIT is the king of income stocks. It has paid 632 consecutive monthly dividends and increased the dividend payment 119 times since its IPO in the 1990s. And the REIT has been growing stronger through acquisitions of late. Earnings grew at 9.2% for 2022, which is above the historical average, and it did it in a challenging year. O has been trending slowly higher since the middle of October and should continue to be an investor favorite in this tough market. HOLD

The Williams Companies, Inc. (WMB – yield 6.0%) – This midstream energy company has been a bummer this year. After outperforming its peers in the down market this fall, WMB is underperforming both the overall market and its peers YTD. Williams reported solid earnings last quarter with 21% full-year growth over 2021. The issue is that the company expects slower growth of just 3% in 2023 as the benefit of recent acquisitions draws tougher comparisons. But the dividend is rock solid with 2.37 times coverage from cash flow and future growth is likely to resume at a stronger clip in the years ahead. It also has an inflation- and recession-resistant business that should help it to outperform the market through the rest of this year. BUY

Medical Properties Trust, Inc. (MPW – yield 12.1%) – MPW plunged 27% in the last month 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 main concern now is the safety of the dividend. With such a high payout and limited growth over the next year, there is concern. The stock was reduced to HOLD last week and any further weakness in the stock may prompt a sale, even via “Special Alert.” HOLD

Dividend Growth Tier

AbbVie (ABBV – yield 3.9%) – ABBV moved higher in February as the overall market fell after pulling back in January when the market rallied. In the near term, ABBV is somewhat tied to the fortunes of the defensive sectors. Nevertheless, the recent strength is encouraging because this is the year its U.S. Humira patent expires, and earnings are expected to decline this year as a result.

But fear of this year has been reflected in the stock price for years. That’s why ABBV sells at an earnings multiple well below that of the overall market. As I’ve long argued, the company has newer drugs growing at a huge clip that can fill the void before long, and the stock should be a big winner longer term. If results are better than expected this year and investors start to see beyond this highly anticipated patent expiration year, ABBV could get a big move higher. HOLD

Broadcom Inc. (AVGO – yield 3.0%) – AVGO has spiked to within about 2% of the all-time high despite the sector troubles, as of Tuesday’s rally. The stock is still in a steep uptrend and has rallied over 50% from the October lows. The semiconductor and software giant reported 16% higher revenues and 20% earnings growth from last year’s quarter. While other companies are struggling with lower smartphone and PC sales, Broadcom continues to benefit from its emphasis on technology infrastructure. HOLD

Brookfield Infrastructure Partners (BIP – yield 4.5%) – The infrastructure juggernaut is up YTD but has trended slowly lower over the past two months or so. The stock is bouncy but has also been hit by the strong dollar and rising interest rates. But it still has incredibly resilient and inflation-protected earnings and recent trends are likely to reverse, or at least abate. It is a very defensive company with a high and safe dividend that should benefit in a continuing choppy market. (This security generates a K1 form at tax time). BUY

Eli Lilly and Company (LLY – yield 1.4%) – After a stellar 2022 where it returned 34% in a bear market, LLY is having a tough time this year, although it has been moving higher lately. LLY is notoriously bouncy and tends to pull back after every surge. Despite the recent earnings stumble, this company is expected to grow earnings by an average of 19% per year over the next five years. It also has two drugs that could be mega-blockbusters in the pipeline that could be approved in the next year.

This recent pullback is an opportunity to pick up a stock that has returned 647% over the last ten years and 353% over the past five at a time when prospects look more promising than they did in the past. LLY was upgraded to a BUY rating on the price decline. BUY

Intel Corporation (INTC – yield 1.9%) – This beleaguered stock has stayed relatively steady since announcing the 66% dividend cut. That implies that perhaps the stock has already bottomed out and the most likely future trend for the stock price is higher. The price is so low already there wasn’t much left to punish. INTC also managed to move over 3% higher last week when the overall market fell 5%. 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. HOLD

Qualcomm Inc. (QCOM – yield 2.6%) – A stellar January was followed by a lousy February. QCOM soared about 29% in January and the price reached the highest level since the summer. But the stock pulled back about 8% in February. And it’s been more downside so far this month. QCOM is tied to the fortunes of the market and the tech sector in the near term. And the sector weakened after a strong start to the year as inflation appears to be hanging around and due to the recent banking issues. At some point this year, the market should start sniffing out the recovery. And QCOM can make up for lost time fast when it moves. HOLD

Visa Inc. (V – yield 0.8%) – I like V over the longer term. It’s a great business that will continue to grow in the years ahead. And the stock is still relatively cheap. After an impressive -3.4% return in last year’s bear market, V delivered strong returns in the earlier part of the year. Even if the market continues to stumble and cyclical stocks go out of favor again, V should continue to hold up relatively well and showed 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. BUY

Safe Income Tier

NextEra Energy (NEE – yield 2.5%) – 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 fell 17% in six weeks before moving higher again this month. 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 still near 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 spiked late last year but has fallen back again. XEL is down about 10% YTD and it’s trading near the low point of the recent range. Meanwhile, inflation is being stubborn and the Fed is remaining hawkish, the same scenario that enabled XEL to strongly outperform the market last year. It’s a good stock to buy almost anytime. But after having gotten cheap ahead of a period of likely relative outperformance, it was upgraded to a BUY. BUY

USB Depository Shares (USB-PS – yield 6.0%) – This preferred stock had rallied strongly after being added to the portfolio. But interest rates spiked higher again and the price fell all the way back to where it was when the stock was added. Rates have since moved lower again but the current banking crisis weighed on this preferred stock, despite there being no tangible reason. It’s a good buy here with the rate back up to 6%. BUY

Invesco Preferred ETF (PGX – yield 6.2%) – Ditto what I said about USB-PS. Longer-term rates are bouncing around and have recently been moving lower again. 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 if the economy weakens. 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. An imminent recession is out the window and rates may continue to bounce around. But this is still an opportunity to lock in investment-grade rates at the highest level in 15 years. BUY