Cabot Income Advisor Weekly Update
The week is representative of the tenuous state of the current market. Continued volatility is a strong possibility. Stocks have had a huge and rapid rebound from the March lows on anticipation of a powerful economic recovery and a booming economy in the third and fourth quarters.
A Great Market for Income
The market is down over the past week after a pretty wild ride. A disturbing selloff is being followed by an impressive rebound.
Last week the Dow Jones fell about 7% in one day. It was the worst day in the market since March. The Fed had issued some rather downbeat and sobering news about the economy on the same day that there was news of the increasing spread of the coronavirus. Since then, the market has regained most of the losses on surprisingly strong retail sales and news of a possible treatment for the virus.
The week is representative of the tenuous state of the current market. Continued volatility is a strong possibility. Stocks have had a huge and rapid rebound from the March lows on anticipation of a powerful economic recovery and a booming economy in the third and fourth quarters. I’m confident that the economy will come back strong and stronger than most people expect.
But I’m not confident in the course of the virus. As well, even with a strong recovery, there are sure to be a lot more ugly economic headlines that can roil the market at any time. Sure, the market could forge higher and even make new highs. But I believe there is still more downside risk than upside potential in the near term.
That said, It’s a great market for income. Despite the overall market rebound, many stocks are still cheap, with higher yields than have existed in a decade. In addition, the upward market momentum is creating high call premiums and a great opportunity to supplement dividend income.
If the market continues to rise, we can still generate a strong income with covered calls, albeit with less appreciation than just owing the stock. If the market pulls back, we can still collect dividends and call premiums and probably be able to write more calls on the same stocks in the future (as they won’t get called away).
Today I have a “Special Alert” for the writing of a call in our Altria (MO) position, below.
Sell MO July 31 $42 call at $1.60 or higher
Expiration date: July 31
Strike price: $1.62
Call price: $1.60 or higher
1. The stock goes above $42
Call premium: $1.62
Dividend: $0.84 (the pay date is July 10th)
Appreciation: $0.88 ($42 strike price minus $41.12 current price)
Total: $3.34 (total return will be 8.1% in six weeks)
2. The stock price stays the same or goes lower
Call premium: $1.62
Total: $2.46 (total return will be 6% in six weeks)
These are the projected returns if you buy the stock and write the call today (of course with some variation as prices will fluctuate somewhat by the time you can execute the trades). However, if you had purchased the stock when it was initially recommended on June 2, when the closing price was 39.66, the projected return in the event the stock closes above 42 on the expiration date would be 9.5%.
AbbVie Inc. (ABBV) Yield 4.9% — Healthcare is the second-best performing market sector so far this year, next to Technology. It’s also a top performer over the past year. The reason is that Healthcare is in the sweet spot of this uncertain market. The sector is relatively immune to an economic downturn but there is also strong bull market growth in the biotech area, where there is some overlap with technology.
AbbVie is situated perfectly as a big pharma company that specializes in biotech medicines and procedures. The stock is also cheap at just 11 times forward earnings. Although the stock is near the 52-week high at 96 per share, it is still well below the all-time high of 140. On a technical level, ABBV appears poised to make another run at the yearly high of 99.35, so I will hold off on writing a call for now.
Altria (MO) Yield 8.3% — The cigarette maker stock last week made a new post-market bottom high and then pulled back with the rest of the market. The stock is likely to continue moving higher as the market looks on track to recoup the loses of last week. MO offers great value and a stupendous yield. Concerns about e-cigarettes and JUUL are already factored into the price as the company continues to grow earnings and easily earn more than enough free cash flow to pay the dividend. I also believe the stock has limited downside in the event the market turns south again. The recent price strength is a great opportunity to write a call on the stock and capture premium to compliment the huge yield.
Innovative Industrial Properties (IIPR) Yield 4.4% — This farm REIT for growers of legal marijuana has been very strong since it was purchased in this portfolio. The closing price on June 2 (the date of the first CIA issue, when the stock was recommended) was 87.82. The stock closed yesterday at 98.71. However, we wrote a call on the stock with a strike price of 95, which limits the upside. Of course, it remains to be seen if IIPR will be trading above 95 on the July 17 expiration date of the call.
This is a strong stock with fantastic earnings growth. But, as a sexy marijuana stock, it tends to bounce around and even exaggerate the moves of the overall market in the short term. If the market strength continues, the stock will run higher and you will miss some of the upside. But, if you purchased the stock and wrote the call when recommended, you will still get a double-digit return in about six weeks. If the stock pulls back, you still keep the dividend and the call premium and can write another one in the future.