A Cautious Outlook from Here
Don’t look now but the market is booming. We are in a rally that has lasted about five weeks. It’s up big again today on hopes of a new coronavirus treatment.
After falling 34% in record time, the S&P 500 has recouped more than half of the losses. As of this writing, the market is down just 15% from the February highs. The S&P 500 is now back to the same level it was at this past October. Clearly the market is optimistic about the speed and strength of the economic restart. And the market usually gets it right.
Will the good times last?
I doubt it. That isn’t to say that the outlook is gloomy. I believe in this country and this economy. We will overcome this virus and come back strong. Good times are ahead for the market and there are still many undervalued opportunities out there. But there is a strong chance that we aren’t out of the woods yet.
While the market is priced at the same level it was this past October, the fundamental backdrop has radically deteriorated. Last October GDP was growing at a solid 2% to 3% annual clip with record-low unemployment and sky-high consumer and business confidence. Compare that to the current situation.
First-quarter GDP numbers just came in and reported a contraction of 4.8%. But that number only includes a few weeks of this shutdown nonsense. There are 26 million new unemployed since the virus. Many businesses will fail and many others will take a long time to overcome the damage already inflicted. Estimates for second-quarter GDP range from a 10% contraction to a 40% contraction.
Of course, the market is forward looking. This abysmal second quarter is what the selloff was about. Now, the market is looking ahead, usually about six to nine months, to a much improved economy. I’m confident the economy will be in much better shape by the end of the year, with an improving outlook. But it still won’t be in the shape it was this past October.
The economic disaster caused by the shutdown is just starting to come to light. It will take a long time for consumers to return to work and regain confidence. Many businesses will be hobbled for a long time after this. And that is factoring in an optimistic economic restart scenario. There could be setbacks. And there will be headline risk.
That said, the market has a way of confounding logical analysis in the near term. It’s possible that the market continues to run higher and never looks back. I hope that happens. But there seems to be too high of a risk of more trouble ahead to buy into the rally at this point.
I believe the market will come back strong, but probably not before another setback or two. For that reason, I am taking a cautious approach with our Cabot Dividend Investor portfolio. This week, I am reducing the rating on two of the few BUY-rated positions.
Rating changes:
Crown Castle International (CCI) moves from “BUY” to “HOLD”
Invesco Preferred ETF (PGX) moves from “BUY” to “HOLD”
High Yield Tier
Brookfield Infrastructure Partners (BIP – yield 5.6%) – This is a great company with defensive revenues from vital infrastructure assets like cell towers, data centers, utilities, railroads, toll roads and more. The company refers to itself as a “grow-tility” because of the defensive revenues combined with growth from new acquisitions and rotating into higher-margin assets. This is a solid and defensive company with a high yield that should be very safe and it’s a great stock to hold through the remainder of this crisis and beyond. BUY
Community Health Trust (CHCT – yield 4.4%) – The small healthcare REIT had a huge and rapid fall in the panic selling of late March. Fortunately, two-thirds of the position was sold during the good market when this stock was a great overachiever and the stock had become overpriced. The down market is wringing out some of the excesses. But that process is completed and the market should love this stock again in the post-virus environment. HOLD
Enterprise Product Partners (EPD – yield 10.6%) – Just when it seemed things couldn’t get much worse in the energy sector, oil (for May delivery) fell below $0 per barrel as the country is running out of places to store unused crude oil amidst the demand collapse during the lockdown. But even in the face of that EPD had moved higher. In fact, it has been in an uptrend since mid-March. It appears that the stock had been so beaten down that even terrible news in the sector didn’t affect it. The company today announced solid second-quarter earnings, but that doesn’t mean anything. It will likely have a very bad second quarter as drillers are forced to stop shipments amid all the price destruction. But the dividend is safe and the price is already reflecting a terrible environment. I don’t know when this one makes a big move to the upside. But it is a great value with limited downside and a rare place to earn a better than 10% annual income while you wait. HOLD
STAG Industrial (STAG – yield 5.4%) – This industrial REIT is a different animal than its peers. It operates warehouses, distribution centers and manufacturing facilities. Some properties are negatively affected by the shutdown. However, the REIT is benefiting from a wave of demand for e-commerce warehouse space. It has suspended acquisitions for the remainder of the crisis and has a lot of cash to pay the dividend. As well, only 5% of tenants have requested any kind of rent relief, representing only about 1% of earnings. The company reports first-quarter earnings tomorrow and we should get a better picture of operational performance. HOLD
Verizon Communications (VZ – yield 4.2%) – The wireless giant reported earnings last week and earnings beat expectations while revenues fell a little short. The company is experiencing less turnover and cancellations as people rely on their phones during the lockdown, but device purchases have also declined. As well, the 5G benefit will likely be somewhat delayed as a result of the lockdown. But the essential story of reliable earnings and dividends for now, complemented by growth from 5G in the future, is intact. This stock has also been a spectacular performer through the bear market. The price is virtually unchanged since the market high in February. BUY
Dividend Growth Tier
AbbVie (ABBV – yield 5.7%) – The healthcare company will report earnings on Friday, but I just don’t know how much they will matter. Earnings have taken a distant back seat to the ebbs and flows of the virus and lockdown. AbbVie has delivered better-than-expected earnings in each of the last four quarters. It is also expected to benefit from drug stockpiling during the virus, as many of its peers have. The stock was flying before the bear market and it has a defensive business and a safe dividend. This is a stock that should be a great holding though the rest of the crisis and well beyond. BUY
Altria (MO – yield 8.2%) – The cigarette maker announces earnings on Friday and they might matter. The JUUL disaster is already factored into the price, as is the long-term trend decline in tobacco sales. But the down market performance has not reflected tobacco’s resiliency in times of recession. The earnings might bear that out. The market needs to be reminded that this is a company that can maintain and grow earnings in any economy. While the earnings of many companies will be pulverized this quarter and next, Altria’s earnings may actually turn out better than pre-virus expectations. I’m hoping for a boost from the earnings report. HOLD
Rating change “BUY” to “HOLD”
Crown Castle International (CCI – yield 3.0%) – This cellular infrastructure REIT was one of the few stocks in this portfolio that was upgraded to a BUY in the panic-stricken days of the selloff, and for good reason. Cellular service is a main technology helping the country through this crisis as people depend on the service more than ever as they are stuck at home. As well, new 5G technology continues to roll out in haste, pandemic or no pandemic. The stock has recouped just about all the losses since the market highs of February as CCI has surged nearly 40% from the March lows. It announces earnings after the bell today. It may well be on the verge of making new all-time highs. However, given the uncertainty that still remains in this bear market and the fact that this is a rare stock no longer even selling at a discount, I’m reluctant to initiate a new position at the current level. HOLD
Innovative Industrial Properties (IIPR – yield 5.2%) – This is a fabulous REIT in a great niche. Marijuana usage has increased during the pandemic and stores are remaining open. The company is expected to grow earnings by more than 80% this year. And the stock is at a great price at 44% below the 52-week high. It’s a great buy. However, if the market has another powerful down leg it will likely drag this stock down with it. Panic-stricken markets don’t like exotic stocks. For that reason, it is rated a HOLD and not a BUY. But the stock should be a lot higher than it is now in six months or a year. HOLD
Qualcomm Inc. (QCOM – yield 3.4%) – This 5G semiconductor company announces earnings after the bell today that could be bad. Semiconductors are cyclical and this company has a lot of exposure to China. That said, the stock has outperformed its peers and the S&P is this bear market. The reason is that a huge boom from 5G is right around the corner for this stock. 5G is coming and it will be big. Qualcomm has the state-of-the-art 5G smartphone chip. Investors realize that the company is poised to benefit mightily in the post-virus environment. It is well worth holding as you will likely be rewarded for enduring any volatility. HOLD
Valero Energy Corp. (VLO – yield 6.8%) – Demand for refined product has fallen off a cliff as people are driving less and many flights are grounded. However, VLO has risen over 90% from the bottom in March. As well, first-quarter earnings were announced today that beat on both earnings and revenue expectations. Of course, second-quarter earnings will be an unmitigated disaster, but the market has already priced in that fact. Investors are instead looking at the fact that refined product demand will get a huge bounce when the economy restarts and crude oil costs are likely to remain depressed. Meanwhile, Valero just announced that the next dividend will be the same as the last and is backed up by a payout ratio under 50%. This is a stock likely to thrive in the post-virus environment and it will maintain the current dividend and 7% yield in the meantime. HOLD
Safe Income Tier
Alexandria Real Estate Equities (ARE – yield 2.7%) – This defensive life science and research lab REIT announced solid first-quarter earnings. Revenues grew 22% year over year and new acquisitions factored in and earnings increased 6.4% from last year’s quarter. Guidance for the rest of 2020 was only lowered very slightly and the company has pulled back on its acquisitions strategy. The company has plenty of cash on hand as well. The defensive business is likely to be little affected by the recession and the dividend is safe. This is a great stock to hold through the crisis and beyond. HOLD
Invesco BulletShares 2021 Corporate Bond ETF (BSCL – yield 2.7%) – This short-term bond ETF has held up well through the crisis because it isn’t in the stock market, the bonds are short term, and they are investment grade-rated. It’s a great holding in times like these, and it is delivering as advertised. BUY
Rating change “BUY” to “HOLD”
Invesco Preferred ETF (PGX – yield 5.9%) – The price of this preferred stock ETF proved to be somewhat volatile in the down market, falling about half as much as the S&P 500. Since I believe there is significant risk of another pullback and investors in this ETF tend to be more risk averse, I am reducing the rating to a hold until confidence in lasting stability returns to this market. HOLD
NextEra Energy (NEE – yield 2.3%) – This regulated and alternative energy utility announced earnings last week that beat expectations for earnings and revenue on an adjusted basis. Earnings were up 8.2% and revenues increased 13.2%. The utility has outperformed both the market and its peers so far this year but it is still almost 20% below the 52-week high. If the market again turns south, I will recommend a BUY on NEE at a cheaper price. HOLD
Xcel Energy (XEL – yield 2.6%) – Despite the fact that the price had run up very high in the bull market, this smaller alternative energy utility has significantly outperformed both the market and its peer group in the bear market. The fantastic bull market performance is being complemented by stellar bear market performance. Investors love the defensive nature or a utility combined with the growth of alternative energy in any market. I will look to upgrade the stock to buy in another down leg in the market. HOLD
