March 22, 2023

Bleeding Banks Could Temper the Fed

Fallout from the bank failures and the Fed meeting tomorrow make this a big week in the market.

Let’s deal with the banks first. After the two bank failures this week and the buyout of ailing Credit Suisse (CS) over the weekend, the spotlight is on potentially vulnerable small regional banks. Although Silicon Valley Bank and Credit Suisse are very different banks with different problems, the common denominator is the markets, particularly the bond market.

Banks that allocated money into bonds inappropriately ahead of the worst year for bonds ever in 2022 could be in some trouble. So far, crisis seems to be contained by the government bailouts. It seems a crisis should be avoided at this point. But there could be more bank failures and ugly market days ahead.

On the flip side, though, this bank situation may have tempered the Fed’s aggression.

While inflation has consistently moved lower since June, it is still miles above the Fed’s target and the economy remains solid. The Fed needed to induce a further economic slowdown to get inflation under control—and the banking problems may do just that. First, it gives the Fed evidence that things are indeed breaking because of previous rate hikes. Second, the current issues are likely to cause banks to reduce lending going forward, and thus slow the economy.

The consensus has moved from an expected 0.50% Fed rate hike before last week to a tossup between a 0.25% hike and no hike at all. We’ll see what they do. And of course, the Fed statement after the rate decision may be even more important to the market.

The market has rallied this year every time is senses a less aggressive Fed. If this banking situation fades without much pain and the Fed mellows out, it could be very good for the market. A sooner end to this rate hiking cycle and visibility past the economic bottom, could ignite a sustainable rally sooner. The timeline for the end of this bear market may have moved up.

In the meantime, this portfolio is highly weighted in stocks of companies that can maintain solid earnings growth while the economy slows and the overall S&P 500 are likely to fall.

Recent Activity

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

March 22^nd
Medical Properties Trust, Inc. (MPW) - Rating change “HOLD” to “SELL”

Current Allocation
Stocks 30.2%
Fixed Income 20%
Cash 49.8%

High Yield Tier

Enterprise Product Partners (EPD – yield 7.8%) – After moving up to the highest price level since last summer, EPD has pulled back over the past month. It’s only down about 5% over that time and still has a positive 5.35% return YTD. EPD also returned 18.4% in 2022 when the S&P was down 19.4% for the year. Sure, it isn’t exciting, but a stock that provides decent appreciation while providing a massive and secure 7.8% payout is a great place to be in a bear market. The partnership also has very resilient and inflation-protected earnings. (This security generates a K1 form at tax time). BUY

ONEOK Inc. (OKE – yield 6.4%) – Midstream energy stocks have come down with the energy sector over the past month as oil prices have fallen. OKE tends to be more volatile than EPD and is down over 9% over the past month and has returned -6% YTD. Even though midstream energy companies are not levered to energy prices, they tend to move in sympathy with the overall energy sector in the short term. But OKE once again reported strong earnings that beat expectations. The stock should benefit from growing earnings, especially as that becomes increasingly rare in the market. BUY

Realty Income (O – 5.0%) – 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 1990’s. 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, although it has been moving lower lately. O should continue to be an investor favorite in this tough market. HOLD

The Williams Companies, Inc. (WMB – 6.3%) – This midstream energy company has also moved lower over the last month. It’s down about 6%. But it is also down over 10% YTD as it is more levered to gas prices than most other midstream companies. But those price have fallen more than fundamentals justify and I believe than natural gas price leverage will prove a benefit over the rest of this year.

Although Williams reported solid earnings last quarter with 21% full year growth over 2021, the company expects slower growth of just 3% in 2023 as the benefit of recent acquisitions face 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. BUY

Rating change “HOLD” to “SELL”

Medical Properties Trust, Inc. (MPW – 12.1%) – I believe MPT is a solid REIT in a very recession resistant business. The market doesn’t seem to agree. Some of its tenants have had problems paying rent. But these are well chosen properties that can find other tenants and they can recoup missed rent payments later. Still, the banking crisis and the increasingly negative economic outlook in the near term makes it nearly impossible for a company already under pressure to get the benefit of the doubt.

While the dividend should be secure with cash flows for the remainder of this year, the company could choose to use the cash flow for a special opportunity. It’s too much risk to continue to take in this market environment. SELL

Dividend Growth Tier

AbbVie (ABBV – 3.8%) – ABBV sold off in January during the cyclical rally but has been trending higher since early February. 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 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 2.9%) – AVGO was added to the portfolio because it’s a highly resilient technology company that is mostly involved in technology infrastructure and earnings are not highly dependent on product sales. That’s why in a tough technology market AVGO has returned 15% YTD, 8% over the past year, just hit a new 52-week high and is within 3.5% of the all-time high. The stock is still in a steep uptrend that began in October and could continue to breakout higher from here. HOLD

Brookfield Infrastructure Partners (BIP – yield 4.7%) – 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. It still has incredibly resilient and inflation-protected earnings, and recent trend are likely to reverse, or at least abate. This 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 still grew earnings 12.7% in 2022 and is expected to grow earnings by an average of 22% per year over the next five years. It also has two drugs that are potential mega blockbusters in the pipeline that could be approved in the next year. BUY

Intel Corporation (INTC – yield 1.7%) – This beleaguered stock continues to provide evidence that it has bottomed. The news has been even worse so far this year with the dividend cut and lower than expected earnings. But the stock was very beaten down already. Even with all this bad news the stock had rallied about 10% in a week, before pulling back somewhat, and is still up 12% YTD. Intel remains 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 above book value. The portfolio will hold on for now. HOLD

Qualcomm Inc. (QCOM – yield 2.6%) – This is a great longer term stock of a company with a huge share of mobile 5G chips and strong exposure to some of the fastest growing areas in technology. Meanwhile, it sells at a very cheap valuation by historical standards. But the stock is getting pushed around by this market and is vulnerable to weakness in the overall technology sector. It falls when investors turn negative on the Fed/inflation conundrum and rises when investors turn positive, like since the banking crisis emerged last week. 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%) – V rallied strongly at the beginning of the year with other cyclical stocks. But those stocks have since pulled back and V has remained tough. True, the stock is tied to the performance of the overall market in the near term. And that could get worse before it gets better. But V held up with a -3.4% return in the 2022 bear market and should hold up relatively well again if the market turns south. It should also fly when the market finally starts anticipating the economic bottom and the next recovery. BUY

Safe Income Tier

NextEra Energy (NEE – yield 2.5%) – This combination regulated and clean energy utility hung 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 in a lower recent range ahead of a period where defensive stocks could thrive. BUY

Xcel Energy (XEL – yield 3.1%) – This clean energy utility stock is also trading in a lower range since selling down in the first two months of the year, although it’s moving higher this month. Meanwhile, the market remains uncertain, and the economy is likely to slow. It’s a good stock to buy almost anytime. But after having gotten cheap ahead of a period of likely relative outperformance, XEL is a good place to be. BUY

USB Depository Shares (USB-PS – yield 5.6%) – This preferred stock has rallied in price after being added to the portfolio as interest rates fell. But it also sold off somewhat because of the banking crisis, which doesn’t affect a huge and well-run bank like USB. The price fell all the way back to where it was purchased but has shot up again over the last week. BUY

Invesco Preferred ETF (PGX – yield 6.2%) – 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