September 27, 2023

Interest Rates and a Possible Shutdown

This market is officially flirting with ugly. The S&P is now down about 7% from the 52-week high and not far from correction territory, down 10% from the high.

The selling intensified over the last week after the Fed struck an unexpectedly hawkish tone at last week’s meeting. The gist of the Fed’s message is that rates may well go higher and will stay higher for longer. The statement pours cold water on the notion that rates will be cut in the near future and reinforces the realization that higher rates are here to stay.

High interest rates are a problem. Mortgage rates are now over 7%. Borrowing money is more expensive across the board. And the easy money days of the last decade and a half will not return. It seems increasingly likely that these high rates will turn the economy south as they ripple through the economy or rise further until they do.

There’s also a looming government shutdown, which is adding to the intensity of the selling. The possibility will likely be a further drag on stock prices for at least another several days and possibly longer.

The high interest rates and sour future prognosis may be killing the rally in technology stocks which had lifted the market indexes all year long. Anything is possible, of course, but the market prognosis for the rest of the year has taken a turn for the worse.

While the market indexes may sputter, there is still opportunity in defensive stocks in utilities, healthcare, and consumer staples. It was already the lows of a bear market for several of these stocks. They are now dirt cheap ahead of a likely slowing economy, which is historically a period of market outperformance.

The fizzling of the growth rally should also prompt renewed investor interest in stocks with more resilient and predictable earnings, especially at the current cheap prices.

Recent Activity

August 29^th
Invesco Preferred ETF (PGX) – Rating change “BUY” to “HOLD”

High Yield Tier

Enterprise Product Partners (EPD – yield 7.3%) – EPD didn’t even budge during a rough week in the market. It continues to hover right around the 52-week high and has been the most resilient of the midstream energy companies in the portfolio. EPD has returned 20% YTD. The energy sector has cooled off as energy prices stopped rising over the past couple of weeks. Enterprise should continue to have the right stuff going forward as earnings should be resilient in almost any economy. (This security generates a K-1 form at tax time). BUY

ONEOK Inc. (OKE – yield 5.8%) – This midstream energy company stock has cooled off over the past couple of weeks, along with everything else, after making a new recent high earlier in the month. But it is still in a good place with a high yield and a resilient business. ONEOK reported solid earnings and raised earnings guidance for the year. Longer term the stock looks solid as the company is expected to grow revenue by an average of 10% per year over the next three years. HOLD

Realty Income (O – yield 6.0%) – This rock solid, legendary income REIT has not lived up to its reputation of late. O just hit a brand new low that is the lowest price for the REIT in more than three years. Defensive stocks have been poor performers all year, but this is silly. O has returned -16% YTD and -12% over the last three months. But operational performance has been sound as earnings were solid with a stellar 99% occupancy rate for its properties and an additional $3.1 billion invested in the quarter in 710 properties. This is now a very cheap and high-yielding stock with an excellent historical track record in a very uncertain market and economy. BUY

The Williams Companies, Inc. (WMB – yield 5.3%) – After a sharp spike higher in the spring, the midstream energy company stock has leveled off and bounced around for the last several months. The stock didn’t benefit from the rally in the more commodity price-sensitive energy stocks over the last several months, as earnings rely on fee business rather than energy prices. I do like the way this company is set up going forward. Earnings should be highly resilient in any economy and the high yield is safe. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 3.9%) – So far, this cutting-edge biopharmaceutical company stock is getting through this challenging year in decent shape. It has returned -2% YTD. But it has been a lot better over the last two months when it has been up more than 13%. It is struggling with shrinking revenues because of the loss of U.S. patent protection for its blockbuster Humira drug. But the company has the pipeline to overcome in the not-too-distant future. The recent solid earnings report emboldens the notion that the revenue drop from the Humira patent expiration will be temporary and AbbVie will turn the corner sooner than expected. BUY

Broadcom Inc. (AVGO – yield 2.2%) – This AI juggernaut has cooled off since the big surge in the spring and early summer. That is to be expected and the stock has still returned a stellar 52% YTD. It started bouncing around in a sideways fashion, but at the much higher price levels. It hasn’t really given up much after the surge but it is currently flirting with the lowest price levels since the surge. The market has gotten tough for technology stocks. If AVGO moves below 800 per share it might be time to repurchase the half position that was sold early in the summer. HOLD

Brookfield Infrastructure Partners (BIP – yield 4.9%) – The tough times for safe stocks continue. Despite strong operational performance in a period of shrinking earnings for most companies, BIP continues to wallow near the 52-week low. But these periods of bizarre underperformance never last. Sure, the stock could languish for a while longer, but it is highly likely to be a lot higher a year from now. Brookfield is targeting 10% average earnings growth and 5% to 9% distribution growth over the next several years. (This security generates a K-1 form at tax time). BUY

Digital Realty Trust, Inc. (DLR – yield 4.0%) – Even this previously hot data center REIT is under pressure in this market. The realization of higher interest rates for longer is causing somewhat of a repricing in the technology sector. It’s not overly concerning at this point because the sector had been up about 40% YTD and a pullback of sorts was likely anyway. But in the longer term the market may not have priced in the additional growth catalyst Digital is likely to get from significantly increasing artificial intelligence spending. BUY

Eli Lilly and Company (LLY – yield 0.8%) – Even LLY is cooling off a little bit. It’s pulled back over 8% from the new high made earlier this month. So far it has just given up the most recent price spike. It is still selling right where it was at the beginning of this month. Investors are unlikely to cool on LLY because the has two potential mega-blockbuster drugs up for FDA approval this year as well as stellar earnings growth for the next several years. HOLD

Hess Corporation (HES – yield 1.2%) – The energy exploration and production company stock hit a new 52-week high two weeks ago but has since fallen about 10%. Oil prices stopped going higher and have been stuck right around $90 per barrel of West Texas Intermediate (WTI). HES is highly levered to energy prices and there may be a sense among investors that prices may have peaked. But a pause in oil prices after a big spike is normal and the pause may be temporary as global supply is still strained amid strong demand. BUY

Intel Corporation (INTC – yield 1.5%) – After hitting a new 52-week high the week before last, INTC has abruptly pulled back 15%. INTC typically pulls back after a spike. But there was also some bad news. At a company event management indicated that it would take longer to turn around revenue and earnings. The semiconductor subsector also had a rough week as many analysts expect the industry turnaround to take longer than previously expected. Plus, the Fed’s hawkish tone on interest rates also hurts the technology sector. Hopefully, the recent bleeding will stop this week. BUY

Qualcomm Inc. (QCOM – yield 3.0%) – The chipmaker stock continues to stink up the place. It has returned just 3% YTD after a rotten 2022 while the technology sector is up over 30% for the same period. The sector is being driven by stocks with exposure to AI that are benefiting right now. It’s a little soon for Qualcomm. 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. This renewed selling in the sector may spare QCOM because it is beaten down already. BUY

Tractor Supply Company (TSCO – yield 2.0%) – The farm and ranch company stock has been getting slapped around as 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 growth while average S&P 500 earnings were down. TSCO should be solid in just about any environment with a low beta and a highly resilient product base. BUY

UnitedHealth Group Inc. (UNH – yield 1.4%) – This defensive health care stalwart is finally showing some real value in the portfolio. While the market has been reeling over the past couple of weeks, UNH is loving it. It’s up over 5% during that time. 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. The stock may be coming alive again as investors are gaining a new appreciation for defense in this market. BUY

Visa Inc. (V – yield 0.7%) – The market turned sour at mid-month and V is getting clobbered. It’s down more than 7% in the last two weeks. V is being dragged down with the cyclical financial stocks right now. But this stock has shown superior resiliency in similar markets. I expect the stock to recoup most of the recent losses if market selling abates. HOLD

Safe Income Tier

Invesco Preferred ETF (PGX – yield 6.5%) – Longer-term rates have moved near the recent high again after the Fed floated the higher rates for longer notion. PGX has a lot of exposure to the banking sector and could be under pressure if the high interest rates trigger more bank troubles in the fall. HOLD

NextEra Energy (NEE – yield 2.8%) – The weakness might be ending as NEE has made a move off the bottom. This stock is still wallowing near a multi-year low, but it has historically been a superstar performer. NEE moved above the low and may be finally perking investor interest. The utility grew earnings 8.6% in the second quarter and 11% in the first half versus the same periods last year. It also has predictably solid earnings going forward because of a considerable project backlog. BUY

USB Depository Shares (USB-PS – yield 5.9%) – This preferred issue has bounced around since being added to the portfolio. It has mostly moved conversely to interest rates but this security has outperformed other investment-grade fixed rate investments. Interest rates are near the highest level since 2007 and the price is still higher than when it was added to the portfolio. BUY

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.7%) – There could be some near-term turbulence with the price on the way to solid longer-term returns and diversification. The fund is holding up well in the recent rising interest rate environment and should benefit if and when rates come back down. BUY

Xcel Energy (XEL – yield 3.5%) – This clean energy utility hasn’t fared any better than NEE in a very tough market for utilities. XEL had been trending lower since the beginning of April and hit a new 52-week low at the beginning of the month. But XEL has moved sharply off the low. This is one of the best utility stocks to own and the dark days may be turning around. XEL is still selling near the lowest valuations in years in an expensive market and ahead of a likely slowing economy. BUY