May 1, 2024

A New Stagflation Worry

What had been a tug-o-war between the souring interest rate narrative and earnings excitement is showing signs of veering in yet another direction.

The news on both inflation and the economy has been worse. The Fed’s favorite inflation gauge, the Personal Consumption Expenditures Index (PCE), came in higher than expected at 3.7% last week. Inflation continues to creep higher this year. And that’s with interest rates already at the highest level in decades.

Meanwhile, recent news indicates an economy that is losing steam. First-quarter GDP was 1.6% versus a forecast of 2.4%. This week, consumer confidence numbers were the lowest in nearly two years as consumers are fretting over high prices and job market uncertainty. Of course, these reports could just be a blip, but investors are starting to worry.

A “stagflation” scenario is gaining increasing traction. That means slow growth with high inflation. That is certainly something to watch for if the economy continues to show signs of slowing and inflation stays high or goes higher.

But I still believe the market should be okay this year as long as interest rates and inflation don’t rise from here, or the economy doesn’t slide all the way into a recession. As long as we remain between those two extremes, the market should be okay.

In the meantime, it is the heart of earnings season. Portfolio positions that reported earnings over the past week include Enterprise Product Partners (EPD), AbbVie Inc. (ABBV), American Tower (AMT), Eli Lilly and Co. (LLY), Marathon Petroleum Corporation (MPC), Visa (V), Alexandria Real Estate Equities (ARE), NextEra Energy (NEE), and Xcel Energy (XEL).

The reports have been okay for the most part. There are two notable reports in MPC and LLY.

Recent Activity

April 3^rd
Marathon Petroleum Corporation (MPC) – Rating change “BUY” to “HOLD”

April 10^th
SOLD Intel Corporation (INTC)

April 17^th
UnitedHealth Group Inc. (UNH) – Rating change “HOLD” to “BUY”

High Yield Tier

Brookfield Infrastructure Partners (BIP – yield 6.0%) – This is a great company with a great business that has a long track record of outperforming the market. But it has had a miserable two years. Although BIPC is well off the lows, it’s still much closer to the 52-week low than high. I will be patient with BIPC and other interest rate-sensitive stocks because attitudes about interest rates may have already hit a low point for this year. The longer-term prognosis is still positive as rates have likely already peaked and Brookfield has some of the most defensive revenues possible and continues to deliver strong operational results which should be on display later this week when Brookfield reports earnings. (This security generates a K1 form at tax time). BUY

Enterprise Product Partners (EPD – yield 7.2%) Earnings – This midstream energy partnership reported solid earnings on Tuesday. Profits per share were in line with estimates and revenues were a lot better as new projects came to fruition. Distributable cash flow was solid with 1.7 times distribution coverage and justified the 5.1% increase. Capital investments were also aligned with strategic initiatives. Overall, the earnings didn’t reflect much change in an already solid story with good stock performance. The massive payout is well-supported, and the energy sector still looks good (This security generates a K1 form at tax time). BUY

Main Street Capital Corporation (MAIN – yield 5.8%) – The Business Development Company didn’t get hurt at all in the rough market. The stock isn’t interest rate sensitive because it has a higher yield, and its companies perform well in a strong economy. Although MAIN is currently selling near the 52-week high, it is still reasonably priced at less than 1.6 times book value and most valuation measures are below the 5-year average. It has also shown resilience in the tough market over the last week. The safe and high yield pays dividends every single month with a strong possibility of supplemental dividends over the course of the year as well. BUY

ONEOK Inc. (OKE – yield 4.9%) – The midstream energy company just made a new high. It’s still in an uptrend that began about a year ago. Unlike most energy companies, OKE has eclipsed the pre-pandemic high. The company is justifying the strong stock performance operationally and that will be tested or reinforced this week when ONEOK reports earnings. Last quarter, ONEOK reported a 42% increase in profits over last year’s quarter on higher LNG volumes and the contributions of the recent Magellan Midstream acquisition. The company also set ambitious guidance for this year. BUY

Realty Income (O – yield 5.7%) – This legendary income stock is still floundering after a rough two years. But it has been going sideways since early February and not pulling back like many of its peers. Perhaps O has seen the worst also and is finally headed for better days. It looks like O will be stuck in the mud until interest rates really move lower, which may or may not happen later this year. But the monthly dividend has been raised every year since 1969. The last two years have been among the worst in this stock’s history, which makes it dirt cheap ahead of an environment that will get better eventually. BUY

The Williams Companies, Inc. (WMB – yield 4.9%) – Like EPD and OKE, this midstream energy company stock has been strong all year but a little weaker this month in sympathy with the overall market. But it’s still hovering close to the high. WMB broke out in the middle of February and the latest pause may be only a temporary setback as the energy sector is still strong. It’s a stable, high-yield stock and the company should deliver solid and dependable earnings in just about any economy. Williams reports earnings this week and hopefully, the report can propel the stock to a new high. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 3.8%) Earnings – The biopharmaceutical company reported earnings last week that beat expectations. But the market wasn’t too excited because the company also slightly lowered earnings per share expectations for next year, and the stock has dipped slightly since the report. Beyond the short-term noise, the good story is intact. Although Humira sales fell 35.9% after losing patent exclusivity, it was less than expected. Meanwhile, the other immunology drugs, Skyrizi and Rinvoq, grew at torrid paces with revenue of $3.1 billion for the quarter. The company is well on track to replace Humira revenues and return to robust growth in the years ahead. BUY

American Tower Corporation (AMT – yield 3.8%) Earnings – This recently underperforming stock may get a boost from better-than-expected earnings. The cell tower REIT reported 9.8% year-over-year growth in adjusted funds from operations per share. They are also streamlining the portfolio by selling underperforming assets and paying down debt. The market hasn’t reacted positively yet but let’s give it a week or so. AMT has had similar interest rate-related gyrations as other REITs. And lately, that has been a bad thing. The exposure to technology and a strong niche business haven’t insulated AMT from the souring interest rate story. But good earnings and a stable interest rate narrative could improve performance. BUY

Broadcom Inc. (AVGO – yield 1.6%) – The chip and software infrastructure company stock rallied 10% last week despite a down market. The reason is that several technology giants reported increased spending on AI-related products and services in their earnings reports which will benefit Broadcom and other AI chip stocks. The increasing investment should be a strong tailwind for Broadcom. The stock had dipped on increasing pessimism about possible price wars with AI products but the larger-than-expected investments reverses a lot of those concerns. HOLD

Digital Realty Trust, Inc. (DLR – yield 3.4%) – It’s been an up-and-down ride with this data center REIT, but mostly up. It did get slapped around a little since the beginning of March. But it seems to be rediscovering its mojo as companies are reporting increasing data center spending this earnings season. DLR can get knocked around in the short term, but the outlook is still good. The data centers will benefit from increasing AI spending, providing Digital with an additional growth catalyst that could last for years. The REIT reports earnings later this week that hopefully reflect the positive data center news we’re seeing from big tech companies BUY

Eli Lilly and Company (LLY – yield 0.7%) Earnings – The pharmaceutical company stock jumped more than 6% on Tuesday morning after reporting earnings. Although the company missed slightly on revenues, earnings per share were much better than expected and, even more importantly, Lilly significantly raised guidance for this year. The main reason is that its weight-loss drug revenues obliterated forecasts with $517.4 million in revenue for the quarter versus an expected $373 million. The company is also aggressively expanding production for future quarters and raised its 2024 revenue projections by $2 billion. The weight-loss drug is a monster and looks like a mega-blockbuster, and the Alzheimer’s drug should get the nod in the next few months. HOLD

McKesson Corporation (MCK – yield 0.5%) – After a brief flirtation with weakness earlier in April, the pharmaceutical supply chain company stock is back to its butt-kicking ways. MCK made another new all-time high last Friday and is still in an uptrend that began in early 2023. MCK just continues to forge quietly higher while no one seems to notice. The pharmaceutical supply chain goliath dominates a market that grows all by itself because of the aging population. It reports earnings next week and could get a further boost. BUY

Marathon Petroleum Corporation (MPC – yield 1.7%) Earnings – The country’s largest refiner fell significantly on Tuesday after reporting lower earnings amid record maintenance shutdowns. MPC was down 7% for the day at midday on Tuesday. But things aren’t nearly as bad as they seem. The company actually beat earnings and revenue forecasts. Earnings are down because of reduced crack spreads versus last year’s near-record first quarter but profits are still historically high. The maintenance shutdowns are necessary and set the company up well for increased volumes ahead of the driving season. Energy companies tend to overreact. But it’s still a good market for refiners and they provide a hedge against escalations of tensions in the Middle East and inflation. HOLD

Qualcomm Inc. (QCOM – yield 2.0%) – The chipmaker stock stumbled earlier this month after a stellar five months prior when the stock soared 60%. But it has moved sharply higher again over the last week on excitement about the earnings season and artificial intelligence. Qualcomm reports earnings later this week. The negative cycle in semiconductors and smartphones that held the stock back last year has likely come to an end. Also, the company is introducing new AI chips for PCs and smartphones. Hopefully, it can get a boost from the earnings report. BUY

UnitedHealth Group Inc. (UNH – yield 1.5%) – UnitedHealth reported earnings last month that provided some good news for a change. The company soundly beat expectations with an 8.6% revenue rise and a better than 10% increase in adjusted earnings from last year’s quarter. The company also issued strong guidance. It was a relief to the market after recent troubles, and the stock has jumped significantly since the report. UNH had been reeling after the cyber-attack caused a huge disturbance in the company and the industry. But UnitedHealth appears to have absorbed the costs while maintaining strong growth in the quarter and future quarters. With recent troubles behind it, the company has solid and defensive earnings and is well positioned going forward. BUY

Visa Inc. (V – yield 0.8%) Earnings – This payment processing global goliath again reported stellar earnings last week. It reported a 10% jump in revenue and a 20% increase in adjusted earnings per share over last year’s quarter. It is still thriving from cross-border transactions and benefits from the recent better-than-expected economic news. Visa also reported upbeat guidance for this year. Although performance has leveled off over the past few months, V should be solid as long as the economy holds up. HOLD

Safe Income Tier

Alexandria Real Estate Equities, Inc. (ARE – yield 4.3%) Earnings – This one-of-a-kind life science property REIT, which owns properties in highly sought-after innovation clusters throughout the country, reported strong earnings last week that beat expectations. Adjusted funds from operation grew at 7.3% over last year’s quarter, and it raised the quarterly dividend by 5%. Occupancy and the rate of acquisitions reflected a solid business and the dividend hike showed confidence. ARE is a great income stock selling at the low end of historical valuations while the company is consistently growing revenues and profits from its niche properties. BUY

NextEra Energy (NEE – yield 3.1%) Earnings – The combination regulated and alternative energy utility reported earnings last week that slightly missed on revenues but beat significantly on earnings. The stock has continued to move higher since. It was a solid report and NEE is now officially turning things around big time. NEE has been trending higher since the beginning of March and is up 23% in that time. It’s also up 44% from the low in October. NEE had been a superstar performer before inflation and rising interest rates. It provides both safety from its best-in-class regulated utility business and growth from its considerable clean energy business. BUY

USB Depository Shares (USB-PS – yield 5.7%) – This preferred stock has just weathered a strong interest rate storm and has still returned about 15% since being added to the portfolio. I believe it is unlikely that rates eclipse the high of this cycle. Even if they do, this security can handle it well. It’s also quite possible that rates fall from here and this stock behaves very well. BUY

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.8%) – Ditto for VCLT. It doesn’t like rising rates. But that’s okay unless rates rise to new levels beyond what has been seen in this cycle. I believe that VCLT is still well positioned after the worst two years for fixed income ever. BUY

Xcel Energy (XEL – yield 4.0%) Earnings – There has been some good news for the alternative energy utility after the price shock last month. Xcel admitted that its equipment was likely involved in the raging Texas wildfire. The extent of the liability is still not known. But the company reported earnings last week that exceeded expectations and reiterated its previous earnings guidance for the year. Unfortunately, the stock price hasn’t benefitted from the earnings news, at least not yet. Early indications are that investors are not yet convinced the liabilities won’t be a bigger problem than the company indicated. HOLD

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