May 24, 2023

The Debt Limit and Beyond

The market is near the highest level since last summer and up over 9% YTD. But it hasn’t made a sustained up or down move since the beginning of April.

It’s been more sideways action for most of the last week. The big obsession now is with the debt limit. No agreement has been reached and the crucial, as laid out by Treasury Secretary Janet Yellen, June 1 deadline is fast approaching. The market can’t seem to move higher until the issue is resolved. But it doesn’t really fall because investors expect the usual last-minute deal.

A deal is certainly the most likely scenario. But we’ll see. Beyond the debt limit there is still a recession risk as well as inflation and the Fed. It’s difficult to see how stocks muster a sustained rally until there is more clarity on these issues. The market has also rallied 20% off the October lows already.

A major rally is also unlikely because of the tradeoff between the Fed and recession. Most economists forecast a recession in the quarters ahead. But there is no sign of one yet. Perhaps the country can avoid a recession. But that means that the Fed will likely stay more aggressive. Neither an aggressive Fed nor a recession will please investors.

Anything can happen of course. But the current issues suggest sideways movement at best for the market in the months ahead. That favors defensive companies that can continue to grow earnings in a slowing economy as well as thrive with continued inflation as well as dividends.

Things can change fast. But that’s the story for now.

Recent Activity

April 25
BUY ½ position in NextEra Energy (NEE)

May 10
Purchased Hess Corporation (HES) - $135.24

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

May 23
Eli Lilly and Company (LLY) - Rating change “HOLD” to “SELL ½”

High Yield Tier

Enterprise Product Partners (EPD – yield 7.5%) – Enterprise reported another solid earnings quarter. Earnings per unit grew at 6.9% while distributable cash flow increased 5.5% over last year’s quarter. 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. (This security generates a K-1 form at tax time). BUY

ONEOK Inc. (OKE – yield 6.6%) – The stock has bounced since being down sharply last week after 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, and Wall Street doesn’t like that. It involves the assumption of Magellan’s $5 billion in debt and $8.8 billion in new equity. That could hurt performance in the near term. The stock has leveled off over the last week and hopefully can build back higher. HOLD

Realty Income (O – yield 5.1%) – This legendary income REIT is the king of income stocks. The returns haven’t been inspiring so far but this stock has held its own in a choppy market. As the economy slows and perhaps moves towards recession, investors will continue to demand safety and O is a highly desirable safe income stock. Although Realty Income is a retail REIT, it is far less volatile than most because of the diversification and remarkably stable clients that offer essential services that are recession resistant. That’s why Realty raised the dividend in the last three recessions. HOLD

The Williams Companies, Inc. (WMB – yield 6.1%) – The midstream energy company once again delivered on earnings 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 and growing. WMB has been a struggling stock this year because of natural gas prices, which have crashed. Also, earnings are expected to slow. The market still isn’t showing this company much love with the stock still well below the 52-week high with much higher earnings. The company just raised the dividend. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 4.1%) – ABBV is a bouncy stock that trends higher over time because it has a great pipeline of drugs, and the population is aging at warp speed. This year it’s dealing with the Humira expiration, which is probably holding it back as well. The stock has fallen from the high end of the recent range to the low end in the last month. But the stock should fly once investors start looking past this year toward a bright future. HOLD

Broadcom Inc. (AVGO – yield 2.7%) – In a sideways and uncertain market that is still technically a bear market, AVGO just made a new all-time high. Yet the stock still sells at a P/E ratio below 15, which is well below the semiconductor industry average. Broadcom reports earnings in a couple of weeks and if recent quarters are an indication, the stock should get a bump. Although it is still somewhat tied to the fortunes of the technology sector in the short run, it’s a great stock that has shown resilience in a tough market and should take off when the sector recovers. HOLD

Brookfield Infrastructure Partners (BIP – yield 4.1%) – The infrastructure company is up more than 12% this month while the market has been flat over the same period. The stock probably 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 company benefited from recent expansions and acquisitions but also showed solid organic growth. Brookfield is a solid holding amid inflation and/or recession while the stock price is well below the 52-week high. (This security generates a K-1 form at tax time). BUY

Rating change “HOLD” to “SELL ½”

Eli Lilly and Company (LLY - yield 1.0%) – LLY continues to blow away the market. It recently made another new all-time high. The stock got a huge bump after earnings when the company reported very promising results from its obesity drug tirzepatide. The following week, Lilly reported promising trial results for its Alzheimer’s drug, another potential blockbuster that could be approved within the year.

LLY is up 38% since I upgraded the stock to BUY in early March. I do like this stock longer term. But it tends to pull back after a big surge. In a better market I might be patient with that since the longer-term trajectory is probably higher. But good returns are hard to come by in this flat market and I want to preserve the recent gain. A higher level of trading is necessary to boost returns in a stingy market. I do fully intend to buy back these shares later. SELL 1/2

Hess Corporation (HES – yield 1.3%) – Energy stocks continue to be choppy for now. The risk of recession later this year or early next year is holding prices back. But 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 when energy stocks move higher again. BUY

Intel Corporation (INTC – yield 1.7%) – Intel posted two quarters of negative earnings and guided for more of the same for the rest of the year. The company also slashed the dividend by 80% to save cash for its ambitious turnaround program. Yet, INTC is up 15% YTD. That indicates that the stock has likely bottomed out already. In addition, the early release of its CPU chip for data centers indicated that production problems have been solved and bodes well for an earlier-than-expected turnaround. HOLD

Qualcomm Inc. (QCOM – yield 3.0%) – The chip maker posted mixed earnings results that the market hated earlier this month. The stock fell 6% on the day of the report. Because of slower smartphone sales as the global economy slows and the market gets more saturated, revenue declined 17% and earnings fell 33% in the quarter. That wasn’t a surprise and Qualcomm beat expectations. But it was pessimistic about the rest of the year and indicated the handset chip market may not have bottomed out.

That’s a problem because handset chips accounted for 77% of revenue. The stock is already down more than 40% from the high on expected lower smartphone sales. There probably isn’t much downside in the stock from here. The stock has bottomed out and leveled off over the last few weeks. HOLD

UnitedHealth Group Inc. (UNH – yield 1.3%) – This recent portfolio addition has strong predictable revenues in a very defensive business ahead of a likely recession later this year. 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 I expect the stock to be solidly higher in the months ahead. BUY

Visa Inc. (V – yield 0.8%) – I like the way V has been hanging so tough near the top 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 has bounced all over the past two years and is currently at the lower end of that range. It has been trending higher since the beginning of March as the risk of recession has grown and defensive stocks have outperformed. But NEE is still more than 15% below the recent high. 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. NEE is also well positioned as a defensive stock with growth in a highly uncertain market. BUY

Xcel Energy (XEL – yield 3.2%) – This clean energy utility stock has been trending lower since the beginning of April. 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 a recession later this year becomes more likely. This stock can both weather turbulent times and excel when the market finally recovers. BUY

USB Depository Shares (USB-PS – yield 5.8%) – This preferred stock took a big hit when the banking crisis heated up. It fell about 18% from the recent high but has since been recovering as panic has waned. Bank stocks have been under some pressure across the board. Although this is a preferred stock of one of the country’s largest banks that has increased deposits, it has taken a hit along with everything else. The bank is rock solid, and this security should continue to rally higher. 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