October 25, 2023

All Eyes on Interest Rates

The market has lost all the October gains. Despite the strong economy and optimistic earnings, interest rates continue to cast a shadow.

The economy is killing it (for now). Third-quarter GDP is expected to exceed 5%. That’s an economy nowhere near recession. And earnings should reflect that economic strength. Strong earnings can lift many stocks higher.

But the benchmark 10-year Treasury yield hit 5% on Monday. It’s an important psychological level. Nobody really knows if 5% will be the peak, or if the rate will continue to run higher from there. The near-term direction of the market is seemingly hanging on that question.

If 5% is the peak, the optimists may win out. That means rates are done climbing. High rates haven’t tanked the economy yet and they will trend down. We may get through this rate hiking cycle and into the next bull market and recovery without much economic pain. Stocks could be off to the races.

But if the 10-year hits 5% and keeps rising higher, the market won’t like it. It will change the perception. If the highest interest rates since 2007 don’t tank the economy, they will rise higher until they do. The outlook could change to rising rates for now, and recession down the road. Instead of being near the beginning of the economic cycle, we would be near the end.

Anything is possible. But the market is unlikely to muster lasting upside traction until this question is answered in the positive. In the meantime, we could continue to bounce around for a while.

The portfolio is well-diversified to handle either scenario. In the meantime, there is big news in a couple of the portfolio stocks.

Recent Activity

October 4
SOLD Invesco Preferred ETF (PGX)
USB Depository Shares (USB-PS) - Rating change “BUY” to “HOLD”
Vanguard Long-Term Corp. Bd. Index Fund (VCLT) - Rating change “BUY” to “HOLD”

October 11
Purchased McKesson Corporation (MCK) - $456.66
ONEOK, Inc. – Rating change “HOLD” to “BUY”

October 25
Hess Corporation – Rating change “BUY” to “HOLD”

High Yield Tier

Enterprise Product Partners (EPD – yield 7.3%) – It’s been a rotten market for the past week but that didn’t fluster EPD one bit. It is still within pennies of the 52-week high. The selloff in interest rate-sensitive stocks didn’t affect it because of its connection to energy and recently rising prices. EPD has returned a solid 14% YTD after a strong performance in last year’s bear market. That huge yield is safe, and earnings are resilient in just about any economy. Meanwhile, the stock still trades below the pre-pandemic high despite much higher earnings. (This security generates a K-1 form at tax time). BUY

ONEOK Inc. (OKE – yield 5.7%) – This historically more volatile midstream energy company stock plunged last week after soaring in the first half of October. Even most midstream energy companies took it on the chin last week. That’s been the trend. The sector pulls back in a market where just about every stock goes down. And then the midstream companies come right back when things stabilize. OKE could get a boost when it reports earnings next week as it has already raised guidance for the year. BUY

Realty Income (O – yield 6.2%) – This rock solid, legendary income REIT has not lived up to its reputation of late. O is still wallowing near the lowest price for the REIT since the pandemic bear market more than three years ago. Defensive stocks have been poor performers all year. But operational performance has been sound as earnings were solid. O had been moving off the low until high interest rates started spooking the market again. Maybe a great track record and a 6% dividend can perk enough investor interest to drive the stock higher from here. BUY

The Williams Companies, Inc. (WMB – yield 5.1%) – The midstream energy company made a new 52-week high last week but has since pulled back a little in the turbulent market. Midstream energy companies are dividend stocks that have held up relatively well. While other more defensive dividend-paying stocks are struggling, midstream energy companies have been rolling merrily along. Williams also operates in an inflation-resistant business and revenues should remain solid even in a slow economy. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 4.1%) – The future looks good. AbbVie has one of the best new drug pipelines in the business at a time when the population is aging at warp speed. The megatrend tailwind combined with the quality drugs and treatments should produce strong longer-term gains. But revenues are falling this year as the company has lost patent exclusivity for the blockbuster Humira drug in the U.S. So far, ABBV is weathering this challenging year OK with a -9% YTD return.

Shrinking Humira revenues should be overcome with the company’s strong new drugs and pipeline in the future. If AbbVie can follow last quarter’s positive earnings surprise when it reports later this month, the stock could surge higher as investors sense that it might turn the Humira corner sooner. BUY

Broadcom Inc. (AVGO – yield 2.1%) – This AI juggernaut has bounced around and basically gone sideways since June. But it has found a home in the much higher range after the spring surge. It isn’t giving much back. AVGO has already returned 56% YTD and it might not be done yet. Artificial intelligence gives the company a huge growth catalyst going forward, and it isn’t going away. HOLD

Brookfield Infrastructure Partners (BIP – yield 6.6%) – It’s a tough market for defensive dividend stocks and BIP is getting clobbered. It’s down 34% in the last three months. Despite strong operational performance, the stock performance just keeps getting worse. Sure, rising interest rates hurt companies like this because they have high relative debt and competing fixed rate investments become more competitive. But this performance has been too ugly for just that.

It may be that the infrastructure company has been acquiring more assets in cell towers and data centers as well as a huge joint venture with Intel for semiconductors. Those areas tend to be more cyclical than other infrastructure assets like toll roads and power lines. The recent decline is likely a combination of interest rates and increased exposure to technology. Hopefully, the earnings report next week will remind investors of that fact. (This security generates a K-1 form at tax time.) BUY

Digital Realty Trust, Inc. (DLR – yield 4.2%) – The spike in interest rate since late summer has pulled DLR down from the high. Rates hurt both technology stocks, as growth projections shrink from higher costs, and REITs, as competing fixed rate investments become more competitive. But business is strong, and the AI craze will add another growth catalyst in the quarters and years ahead. It’s also possible that interest rates are peaking. The company reports earnings at the end of the week and a good report could give DLR a lift. BUY

Eli Lilly and Company (LLY – yield 0.8%) – Even LLY pulled back a little bit last week. The stock has been bouncing around in the past couple of months but on an upward trend. It tends to pull back a little off the high and then turn around and make another new high. Investors are unlikely to sour on LLY because it has two potential mega-blockbuster drugs up for FDA approval this year as well as stellar earnings growth for the next several years. HOLD

Rating change “BUY” to “HOLD”

Hess Corporation (HES – yield 1.1%) – Chevron Corporation (CVX) announced the purchase of Hess Corporation for $53 billion. HES shareholders will receive 1.025 shares of CVX for every HES share to close sometime in the first half of next year. Based on Monday’s closing prices, that would provide HES shareholders with about $165 per share. The Monday closing price of HES was $161.30 per share.

This changes things. Chevron wants Hess’s Guyana properties, which is the largest crude oil discovery in the last decade and one of the most profitable. The acquisition will lessen the upside for HES because it is now tied to CVX shares, which has less leverage to crude oil prices. Now, owning these shares is the same as owning CVX.

The portfolio will continue to HOLD the HES shares, downgrading from a Buy. Although the potential upside from oil prices as well as a likely very positive earnings report on Wednesday is now muted, the current Middle East turmoil could cause a significant rise in oil prices and CVX stock if the conflict spreads. The current situation offers more upside potential than downside risk at the current time. HOLD

Intel Corporation (INTC – yield 1.4%) – Interest rate angst is again dragging the stock price lower. INTC seems to want to go higher in all but the toughest environments for technology stocks, which it has been lately as the benchmark 10-year Treasury is flirting with the psychologically important 5% level. The stock had a huge spike higher in the late summer and a pullback after such a move is normal, especially in a lousy market. The fact that INTC is avoiding falling back into the abyss inspires confidence that the stock is cheap ahead of a brighter future and investors are interested. The earnings report later this week could give the stock a boost despite the current tough external environment. BUY

McKesson Corporation (MCK – yield 0.5%) – The market will bounce around in the near term. Sector performance rotates. In six months, we could have a solid economy or a recession. But McKesson’s business will continue to hum along regardless of what happens. It caters to a market that is growing all by itself and demand is unaffected by inflation, the Fed, GDP, or whoever is President. I don’t know what the next month holds for MCK, but the longer term should be stellar. BUY

Qualcomm Inc. (QCOM – yield 2.9%) – The chipmaker stock continues to struggle through this year. The sector was being driven by stocks with exposure to AI that were benefiting until interest rates spoiled the party. It’s a little soon for Qualcomm to benefit from AI upgrades, as they haven’t made the way into smartphones yet. The company is highly dependent on smartphones. And sales have been falling as the 5G cycle comes to an end and the global economy is sputtering. But smartphone sales may have bottomed out. The stock sells at a forward P/E ratio below 11 times, which is cheap considering the cycle and the growth opportunities in the internet of things and other AI applications. BUY

Tractor Supply Company (TSCO – yield 2.1%) – The farm and ranch retail company stock is well off the high made in April. Investors are worried about the continued resiliency of the consumer. But Tractor’s rural consumers have already been weak for a while and the company has been successfully compensating with its vast array of staple products. Last quarter, the company delivered 8.5% EPS while average S&P 500 earnings were down. The strong consumer staple element makes TSCO more of a consumer staples stock, and the market has shunned defensive plays of late. The company reports earnings later this week (Thursday) and a good report might get the stock moving higher again. BUY

UnitedHealth Group Inc. (UNH – yield 1.4%) – The recently underperforming healthcare stalwart got hot and moved up over 12% in a month, although it has pulled back slightly over the past week. The company has extremely resilient and defensive earnings in an uncertain market. Operational performance is stellar and UNH is a superstar that has blown away the returns of the overall market over the past five- and 10-year periods. Hopefully, the positive momentum will reignite as the market stabilizes. BUY

Visa Inc. (V – yield 0.8%) – V did pull back from the high made in September in the tough market. But it has significantly outperformed the market over the past year and is still in a longer-term uptrend. It could take off again if the good economic news continues and the consumer stays strong. But it has also shown resiliency in lousy environments. V returned -3.4% in last year’s bear market. It should be a longer-term winner. We’ll see what happens in the next few months. HOLD

Safe Income Tier

NextEra Energy (NEE – yield 3.4%) – The rollercoaster continues. NextEra reported earnings today that beat estimates and grew 10.6% from last year’s quarter. NEE spiked over 6% Tuesday morning after the report. It is welcome news for a stock that had been down 35% YTD. The stock bottomed after its subsidiary, NextEra Energy Partners, LP (NEP), announced that it is cutting the projected distribution growth rate from 12% to around 6%. Investors feared that slower subsidiary growth will negatively affect the parent company’s growth rate even though NextEra is sticking with its growth projections.

But the stock has since moved convincingly off the bottom. Management also reiterated previous growth projections and said the company expects to deliver earnings near the top of the expected range through 2026. The selling was way overdone. Hopefully, the momentum continues. HOLD

USB Depository Shares (USB-PS – yield 6.7%) – This preferred issue has had a tough month and now sells at the lowest price since being added to the portfolio. The reason is high interest rates and the Fed’s “higher for longer” prognosis. But this investment grade fixed income vehicle now yields 6.7%. And interest rates may be peaking. HOLD

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 5.0%) – There could be some near-term turbulence with the price. This long-term bond fund is vulnerable to rising interest rates. There is a good chance rates will be lower than they are now down the road, but they could go higher in the near term. HOLD

Xcel Energy (XEL – yield 3.6%) – Despite the turbulence of last week, the dark days for utilities may be coming to an end. The lows may be in. XEL had a convincing 10% move off the low. This is one of the best utility stocks to own and the recent week’s debauchery may prove to be very temporary. XEL is now selling close to the pandemic bear market lows of three years ago ahead of a likely slowing economy. Even if interest rates do hurt earnings, the damage is already priced into this stock. BUY