Cabot Income Advisor Issue: July 27, 2022

This week’s GDP number should confirm that we are in a recession. That might be good news for the market.
The worst situation for stocks tends to be a “looming recession”. Stocks tend to fall most as a recession approaches and in the early phases of an actual recession. Stocks also tend to recover before the economy because the market anticipates six to nine months into future. In a typical recession, stocks fall before it hits and recover before it’s over.

If this week’s number confirms that we are in a recession that began at the beginning of the year, the market should be in a more desirable position than if a recession is anticipated later this year or early next year.<.p>

The recent rally in technology is encouraging. I mentioned in last month’s issue that technology stocks had fallen before the overall market and were likely to recover before most other sectors. Since then, portfolio position Qualcomm (QCOM) is up nearly 30%.

This month’s issue highlights another technology stock, Intel (INTC) . The stock is still very cheap with bright prospects in the future. If the market turns south again, the stock should hold up better than the technology sector and be a solid longer-term hold. But if this rally in technology proves to be lasting and QCOM gets called away, we will still have another tech stock that should move higher as well and provide a great call writing opportunity.

A Recession is Better Now Than Later

The GDP number coming out later this week is likely to confirm that we are currently in a recession. And that might be the best news this market has had in a while.

The definition of a recession is two consecutive quarters of negative GDP growth, or economic contraction lasting several months. First quarter GDP growth was negative 1.6%. The consensus estimates for second quarter GDP, which will be reported later this week, is negative 1.5%. If the number does indeed turn out to be negative, that’s a recession.

A recession is not the worst situation for stocks. The worst situation for stocks tends to be a ‘looming recession”. Stocks tend to fall most as a recession approaches and in the early phases of an actual recession. Stocks also tend to recover before the economy because the market anticipates six to nine months into future. In a typical recession, stocks fall before it hits and recover before it’s over.

If this week’s number confirms that we are in a recession that began at the beginning of the year, the market should be in a more desirable position than if a recession is anticipated later this year or early next year. Which is better, anticipating increasing pain in the near future or learning that the pain you’ve already experienced might be the worst of it, and it might be over sooner than previously expected?

The hope is that the contracting economy will temper this inflation, and the Fed will quell its aggressiveness due to deteriorating economic conditions and falling inflation. The Fed could be all done raising rates by the end of the year and maybe even talking about easing again early next year. We could be much closer to the end of the market pain than the beginning. There might be light visible at the end of the tunnel.

Of course, there’s no guarantee of that scenario. A recession might be avoided now and still happen later. Or a current recession could get a lot worse before it gets better. The recent rally off the lows could be a bear market rally or the beginning of the end of the bear market. We’ll see.

The recent rally in technology is encouraging. I mentioned in last month’s issue that technology stocks had fallen before the overall market and were likely to recover before most other sectors. Since then, portfolio position Qualcomm (QCOM) is up nearly 30%.

What to Do Now

This portfolio sold calls on several stocks that had been performing well in this difficult year for the market. Many of those stocks were called away at expiration. It turned out well for the most part. Not only did we generate a high income, but we also took profits ahead of a deteriorating market.

But the positions remaining in the portfolio either fell after we sold calls or fell after being purchased and we never got the chance to sell calls. As a result, most of the portfolio positions remaining are in more cyclical stocks that are lower than the purchase price. But that could be a good positioning going forward.

The stocks that tend to rally the soonest and the most coming out of a recession tend to be the cyclical stocks that got clobbered the worst. These more cyclical stocks have rallied over the past month. We’ll see if the strength lasts. In the meantime, they are still generating high dividend payouts. The portfolio will also seize more such opportunities if this rally shows more evidence of being the real thing. Stay tuned.

In last week’s update, a covered call was highlighted in QCOM. The stock has enjoyed a strong rally over the past months and the call premium is high. I do like the stock over the remainder of this year. But it seemed prudent to grab a great income opportunity after the stock had rallied in this still uncertain market. But if things go well for this market, it could be that we get a stock called away in the early phase of a bigger rally.

To counter that risk, this month’s issue highlights another technology stock, Intel (INTC). The stock is still very cheap with bright prospects in the future. If the market turns south again, the stock should hold up better than the technology sector and be a solid longer-term hold. But if this rally in technology proves to be lasting and QCOM gets called away, we will still have another tech stock that should move higher as well and provide a great call writing opportunity.

Monthly Recap

July 15
SBLK July 15 $34 calls at $1.60 - Expired

July 20
Sold QCOM Sep 16 $145 calls at $11.75 or better

July 27
Buy Intel Corporation (INTC)

Featured Action: Buy Intel Corporation (INTC)

Yield 3.7%
Intel is an icon of the technology revolution. The company makes chips or processors that are essentially the brains of the computer. It is one of the largest semiconductor companies in the world with $79 billion in annual revenue and holds by far the largest market share of the PC and server processor markets.

Sure, INTC has fallen along with the tech sector, although not as much as its semiconductor peers. But this stock crashed all on its own before this year’s selloff, when other technology stocks were doing just fine. Intel had its own individual meltdown. Recent market turmoil has made it even cheaper. The stock is down nearly 43% from the 2021 high.

INTC had been a phenomenally performing big tech stock until about five years ago. In fact, INTC returned far less than the overall market while the sector vastly outperformed it over the last five years. What happened?

Intel has been losing ground to the competition, mainly Advanced Micro Devices (AMD) and Nvidia (NVDA). Intel missed the boat on smartphone chips. Competitors cornered that market and Intel was never able to break in. These emboldened competitors also cornered new markets as Intel struggled. And there’s been more bad news lately.

Last fall, Intel announced that production problems would delay the rollout of its next generation of chips due to problems in the manufacturing process, giving an opportunity to the competition. INTC plunged 10% on the news. Then, in February, Intel reduced 2022 earnings guidance to $3.50 per share from $5.47 in 2021, a decline of 36%. The market didn’t like that either.

The reason for the dip in this year’s earnings is because Intel will focus on the future by investing a record $27 billion on new products, compared to capital expenditures of $18.7 billion last year and $14.3 billion in 2021. It’s like a sports team that sacrifices a playoff run for a year or two in order to rebuild in a meaningful way that could potentially provide years of championship runs.

Intel is rolling up its sleeves and taking on the competition. The company had been the best in the business on such investments and still has the resources, the expertise and the experience to deliver like few other companies. There are some hugely promising growth opportunities.

Intel is already making huge strides in sizable growth opportunities where it has had little market share in the past. It has already developed superior chips in the profitable gaming and data center CPU markets and plans to aggressively compete.

AMD’s earnings have been primarily driven by gaming and crypto mining. The gaming market is currently dominated by AMD, but Intel is already making serious inroads. It also has next generation chips coming in 2023 and 2024 that are superior to AMD’s next generation. There’s huge growth potential in that market.

Intel has an 85% share of the supercomputer market and a massive share of the data center server market, which is a huge growth business as the number of connected devices continues to accelerate. The is also opportunity in the data center CPU market that is forecast to grow to $21 billion by 2026. Nvidia currently dominates with an 80% market share. But Intel has new technology coming in the next few years that is supposedly superior to Nvidia’s.

Intel is also planning to aggressively expand its foundry business, where chips are manufactured. The chip maker recently made a $5.4 billion acquisition of foundry company Tower Semiconductor that should close around the end of this year.

Meanwhile, the stock is dirt cheap ahead of very promising growth in the years ahead. It currently sells at a forward price/earnings ratio of just 11 times, which is below its average valuation over the last five years and well below current market index multiple. It also pays a solid 3.7% yield at the current price with a payout that is likely to grow.

If the market gets worse and hits new lows, INTC is still a great longer term holding that is already dirt cheap. If the market, or just tech stocks, rally from here, INTC should benefit and provide a great call writing opportunity to replace QCOM after shares get called away at options expiration.

Portfolio Updates

Global Ship Lease, Inc. (GSL)

Yield 8.6%
Things have been rough for this container shipping company over the past several months. Although the company has posted solid operational performance among a strong supply/demand dynamic, fears of slowing global growth and recession talk have taken a toll. GSL fell 47% from the beginning of April to mid-July. But the stock may have already hit the lows.

The stock had a massive sell down ahead of a global growth slowdown that may prove to be rather mild and short-lived. Shipping stocks may also be in a secular bull market as supply, especially for container ships, won’t keep up with growing demand in the years ahead. Investors have been sensing the selling may be overdone as the stock has rallied 14% over the past few weeks. We’ll see if this positive scenario continues to play out in the weeks ahead. HOLD

Global Ship Lease, inc. (GSL)
Latest ex-div date: August 23, 2022, est.

ONEOK, Inc. (OKE)

Yield 6.4%
This midstream energy stock has fallen well off the highs over the last few months. The red-hot energy sector got cold as a near term recession became more likely and energy price have fallen. But OKE is not dependent on commodity prices, but rather volumes of natural gas through its systems. Those volumes are likely to remain strong amidst continuing global supply strains. This stock has growing earnings, a cheap valuation and a sky-high dividend that is rock solid. OKE should be a relatively good place to be over the rest of the year no matter how things shake out. BUY

ONEOK, inc. (OKE)
Next ex-div date: July 29, 2022, est.

One Liberty Properties, Inc. (OLP)

Yield 7.0%
The operational performance at One Liberty remains strong and it remains a strong dividend payer. It’s in the more cyclical industrial property business where the supply/demand dynamic remains extremely strong. One Liberty should continue to deliver strong results to back the dividend and should have strong upside traction if the market recovers. This is another stock that may have already hit the low with improving results going forward. HOLD

One Liberty Properties, Inc. (OLP)
Last ex-div date: September 17, 2022 est.

Star Bulk Carriers Corp. (SBLK)

Yield 22.0%
The story has been similar to GSL but not as severe. The selling only took SBLK down about 30% from the high. It’s also up 20% in the last two weeks. The stock is at a bargain price and is an incredible income generator. The supply/demand dynamic remains strong for these shippers and rates will likely remain well above the levels of the last decade in the years ahead. We are likely in a secular bull market for shipping. Hopefully the rally lasts. HOLD

Star Bulk Carriers Corp. (SBLK)
Next ex-div date: September 3, 2022, est.

Qualcomm Corp. (QCOM)
Yield 2.0%
The semiconductor stock is on a tear. It’s up over 27% since being recommended for purchases in last Month’s June CIA issue. Although the technology sector has been positive over the last month, QCOM has blown away the sector returns. Earnings are in a strong growth phase and will likely continue to be for a while. The company is also very well positioned for the longer term. Investors are realizing the value, but the market remains uncertain. BUY

Qualcomm Inc. (QCOM)
Next ex-div date: August 31, 2022

Visa (V)

Yield 0.7%
V got knocked back amidst all this recession talk and the downgrading of global growth projections. But the stock is always very quick to rebound when the market selling abates. It seems that the price is only held artificially low with intense market pressure. That bodes well for how the stock will behave when the market recovers. Visa continues to get a huge benefit from the removal of Covid restrictions globally despite slowing global growth. I was very tempted to sell a call on V this week. But I’m holding out for more. HOLD

Visa Inc. (V)
Next ex-div date: August 12, 2022, est.

Existing Covered Call Trades

Sold QCOM Sep 16 $145 calls at $11.75 or betterThe calls were targeted last week at a price of $10 or better. But by the time the update became available the stock moved higher. The lowest price you would have gotten by acting on the recommendation was $11.75, so that is the price that will be used in the income and return calculations. The stock has been on a tear and I like the prospects over the rest of the year. But this is still a highly uncertain market and it’s a safer bet to take the income in the near term, especially with so few other opportunities at this point.

Income Calendar

Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Income Advisor for an explanation of how dates are estimated.

The next Cabot Income Advisor issue will be published on August 24, 2022.