The vaccine is changing everything. Stocks that had been left for dead by the market recovery are springing back to life and leading the market higher.
One area of opportunity ahead of the New Year is in banks stocks. As a cyclical sector, banks took it on the chin during the pandemic. They crashed during the bear market and have lagged the recovery. But they are rising fast and have great momentum ahead of what looks to be a promising year for the sector.
In this issue, I highlight one of the very best and most profitable banks in the country. It still sells at a great value, pays one of the highest dividends in the industry and now has solid upward momentum.
Cabot Dividend Investor 1220
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Profit from the Resurgence of the Banks
The vaccine is changing everything. Stocks that had been left for dead by the market recovery are springing back to life and leading the market higher.
A coronavirus vaccine could end the pandemic and usher in a full recovery in 2021. A more complete recovery would lift the fortunes of real economy companies that are still hampered by the remaining lockdowns and restrictions.
That’s great news because many stocks in energy, finance, industrials and travel and leisure are still cheap in an expensive market. There are also a lot of high dividend payers among these previously beleaguered sectors recently on the rise.
One area of opportunity ahead of the New Year is in bank stocks. As a cyclical sector, banks took it on the chin during the pandemic. They crashed during the bear market and have lagged the recovery. In fact, financials are the second worst performing S&P 500 sector YTD.
Bank stocks are still cheap but rising fast. A full recovery will greatly improve the situation for the sector with higher interest rates and more demand for loans. The Invesco KBW Bank ETF (KBWB), which tracks an index of national money center and regional banks, is up 25% since late October but still down 20% from the pre pandemic high. The stocks still offer value and have recently accumulated momentum as well.
Of course, many people might grimace at the mention of bank stocks. It’s a hangover from the financial crisis. Banks were at the center of the financial crisis. Not only were many teetering near bankruptcy but even when they recovered they had to deal with a regulatory onslaught. As a result, the sector had a lousy time in the last bull market. Some of the largest banks are still priced below pre financial crisis levels.
Banks are also in far better shape coming out of this recession than the last one. They are far less leveraged and extended and much more financially secure. This recovery and bull market should be a lot kinder to the sector. And we are likely in the very early stages of a new bull market.
Right now, banks are cheap in an expensive market ahead of what is likely to be a year of greatly improving conditions and profits in the sector. The recent rally in bank stocks gave us a taste of what likely lies ahead in 2021.
Of course, it still matters which banks you buy. In this issue, I highlight one of the very best and most profitable banks in the country. It still sells at a great value, pays one of the highest dividends in the industry and now has solid upward momentum.
What to Do Now
This has been quite a year. Good riddance.
Let’s recap very briefly. The world was devastated by pestilence. Lockdown restrictions forced everyone to live like monks and crashed the economy. But the market loves it. It’s soaring to new all time highs.
I probably didn’t do the year justice. But that’s the gist. Let’s not dwell on things we already know but rather focus on what might be in store for 2021.
This is the time of year when Wall Street prognosticators come out to the woodwork with useless predictions for the New Year. How many forecasted a pandemic for 2020? Of course, how could anyone have seen that coming? That’s why I’m not big on predictions.
Nevertheless, calendar years break the unrelenting passage of time into measurable, bite-sized increments. The cusp of a new one is a great moment to stop, get off the train and look where we are and where we might be going.
The economy is recovering strongly and beyond expectations. Third quarter GDP rose a remarkable 33%. But the economy still has one arm tied behind its back as many restrictions are still in place. The vaccines promise to end the pandemic and unleash a full blown recovery in 2021. That’s why the market has been so euphoric.
Technology stocks have driven the market higher. While the market indexes are at all-time highs, most individual market sectors are not. In fact, many stocks and sectors are deep underwater for the year. It is these stocks that have come alive recently and are leading the market high in the recent rally.
Several stocks in the portfolio that have not performed well during the year are on fire recently. Valero Energy (VLO) is up 60% since late October and Enterprise Product Partners (EPD) has risen over 20% during the same time frame. The dogs of the portfolio have become the most promising in the weeks and months ahead.
A few weeks ago EPD was raised to a BUY and today VLO is also being raised to BUY. While these stocks had great value and high dividends, they were languishing. Now they have momentum too.
At the same time, stocks that were already working are still doing very well. Brookfield Infrastructure Partners (BIP), AbbVie Inc. (ABBV) and Qualcomm (QCOM) have all been steadily on the rise.
Everything is working right now. We are riding profits to higher profits while the underperformers are springing back to life. In this issue I upgraded two stocks from a “HOLD” to a “BUY”. Things are good. Of course, that could change in the weeks and months ahead and I will of course make adjustments.
Please see the section at the end of the newsletter, after the portfolio recaps. I highlight two other portfolio positions that are well worth buying at current prices.
Featured SToCK
U.S. Bancorp (USB)
U.S. Bancorp (USB) is the fifth largest bank in the United States and the country’s largest regional bank with over 3000 bank branches in 25 states in the Western and Northern US. The Minneapolis bank was founded in 1863 and now has more than 70,000 employees and $543 billion in assets.
Like most regional banks, revenues are generated primarily from net interest income (NII), which is the rate spread between the cost of money and the loan interest charged to customers. Half of the loan volume is to businesses with the rest primarily from residential mortgages and personal loans. The rest of the revenue is derived from banking fees, which provide steady income and valuable diversification during hard times.
I like USB right now because it’s perhaps the best-run bank in the country, it’s cheap and the prospects look good from here. Let’s take those one at a time.
A Great Bank
This is one of the best-run banks in the country with peer-leading return on assets (ROA), return on equity (ROE) and efficiency ratios. The ratios are a fancy way of saying that it is very profitable and has resilient earnings, which is why it’s a favorite of Warren Buffet’s. Of particular note is a very significant fee-based business that provides a big measure of stability that other banks don’t have.
The proof is in the pudding. Let’s take a look at how it has performed in hard times. In the financial crisis, it was one of the few banks that remained profitable. USB vastly outperformed the banking index through the financial crisis and recovered far quicker in the aftermath. Most of the nation’s largest banks never completely recovered from the financial crisis and are still selling at prices below the pre-financial crisis highs. USB eclipsed the pre-financial crisis high by 2013.
U.S. Bancorp has been resilient in this pandemic recession as well. In the second quarter, despite a loss from write-offs, operational profits only declined 6%, while the GDP shrank over 30%. The bank reported positive $0.99 earnings per share in the third quarter. That was lower by 17% than the year ago quarter but revenues actually increased 2% and loan volumes rose. And that’s as bad as it got.\
It’s Cheap
Despite a recent move higher, USB is still 26% lower than it was a year ago. As I mentioned above, banks have struggled mightily during the pandemic. Banks are cyclical and you don’t want own them during a recession. You want to own them coming out of a recession, which is where we are with the vaccines coming and the prospect of a full recovery next year.
This is a bank that can recover very quickly when conditions improve. It also tends to be one of the first that investors turn to as the sector prospects improve.
Prospects are Good
Banks took a big hit for several reasons. The primary way banks earn money is from net interest income (NII), the difference or spread between the cost of capital and the rate charged to borrowers. As interest rates crashed during the pandemic, profits from NII have fallen with them. The 10-year Treasury bond rate, a benchmark for longer term interest rates, fell from 1.84% just before the pandemic to 0.53% by the summer. It is also down from a recent high of 3.23% in late 2018.
In addition to lower spreads, banks also had to contend with falling loan demand during the shutdowns as well as a higher level of defaults, which accompany any recession. It all adds up to a miserable soup with falling profits.
All these problems should reverse in a full recovery. Longer term rates will likely trend higher as economic activity picks up and increases spreads and NII. The ten year treasury has already risen from 0.53% in the summer to 0.91%. As well, loan demand always increases as the economy gains traction and loan losses also fall.
USB is a great bank to own. And the timing may be just right.
U.S. Bancorp (USB)
Security type: Common stock
Category: Banking
Price: $44.75
52-week range: $28.36 - $61.11
Yield: 3.75%
Profile: USB is a massive US regional operator and the fifth largest bank in the country.
Positives
- A stronger recovery next year would lift bank profits and stocks.
- Operational performance has been remarkably resilient through the pandemic.
- It is one of the best banks selling at a cheap price in an out-of-favor industry.
Risks
- Interest rates remain at historically low levels.
- The virus and the vaccine remain uncertain and the recovery could get derailed.
- A Biden presidency could bring more industry regulations.
Portfolio at a Glance
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Portfolio Updates
High Yield Tier
The investments in our High Yield Tier have been chosen for their high current payouts. These investments will often be riskier or have less capital appreciation potential than those in our other two tiers, but they’re appropriate for investors who want to generate maximum income from their portfolios right now.
B&G Foods (BGS – yield 6.9%) – It’s been a crummy month for BGS. While the indexes had one of the best months ever, BGS languished. The market sees it as a pandemic stock and there was a rotation into reopening stocks. As people eat at home more during the pandemic, earnings have exploded and the stock has returned over 60% YTD. But the company should continue to earn revenues better than pre-pandemic levels for a long time, securing the high dividend and making B&G a better company. But the stock just kind of went sideways and hasn’t taken a hit in the changing market. When this market phase ends, BGS should be right there. HOLD
Brookfield Infrastructure Partners (BIP – yield 3.9%) – This infrastructure partnership had a good November, up 16%. Brookfield has a solid third quarter with funds from operations growing 8% over last year’s quarter despite its transportation and utility assets being negatively affected during the pandemic. Highly profitable acquisitions, mostly in cell towers, saved the day. The asset rotation strategy is working and bodes well for the year ahead as Brookfield has been able to acquire valuable assets on the cheap during the recession. I think the post pandemic market will be kind to BIP. BUY
Enterprise Product Partners (EPD – yield 8.6%) –The midstream energy company had strong operational performance during the recession, an absurdly low valuation and a safe dividend. But the market never cared until November. Now EPD has some momentum too. It should continue to benefit along with the rest of the energy sector as we move toward a full recovery in 2021. As well, the high payout and resilient earnings should make it attractive even after the energy sector gets its post pandemic bump. This stock is a steal for income oriented investors, as yields like this backed by such quality won’t last much longer. BUY
STAG Industrial (STAG – 4.8%) – This monthly paying industrial REIT, like so many other REITs, has been in a funk since the summer. It makes sense. When the highest yielding sectors start moving higher investors neglect the other dividend stocks. But this is also an e-commerce stock because of its warehouse properties. And e-commerce is having an epic year. STAG may continue to go sideways for a while but it pays you to hang in there. And the stock should be a winner longer term. HOLD
Verizon Communications (VZ – 4.1%) – This is a great dividend stock and it is approaching the 52-week high. In the past it has underperformed the market, but with considerably less volatility. Things may get better for VZ going forward. The new 5G phones are coming out now and Verizon will likely to be able to upgrade plans on those phones. Longer term, there are a host of new technologies coming that will enable this wireless giant to charge more fees and ring the register. As well, 5G is likely to become a much bigger market driver when we move beyond the pandemic, and VZ will be a fantastic option for more conservative investors. HOLD
Dividend Growth Tier
To be chosen for the Dividend Growth tier, investments must have a strong history of dividend increases and indicate both good potential for and high prioritization of continued dividend growth.
AbbVie (ABBV – 4.9%) – After drifting slowly lower for months after the summer highs, the biopharmaceutical company has had a great surge since the election. It’s up over 20% since November 3rd and recently blew through the old 52-week high. But despite the recent surge, ABBV still sells at less than 9 times forward earnings. The great value is one of the reasons Warren Buffet just took a huge position in the stock. ABBV can be range-bound in the near term, but it should continue to trend a lot higher over the intermediate and long term. BUY
Altria (MO – 8.3%) – The cigarette maker stock has had a nice move from the bottom and has significantly outperformed the market over the last month. It seems that the rotation into value stocks is even benefitting MO. The huge dividend is secure and the stock is priced for longer-term failure. It still doesn’t have a bankable offset for the increasing downward trend in cigarette smoking after its disastrous foray into e-cigarettes with JUUL. Right now, it’s a good income stock with an upside surprise to the longer term prognosis possible if not likely. BUY
Digital Realty Trust (DLR – yield 3.3%) – This data center REIT is a fantastic opportunity right now. DLR has been the worst performing stock in this portfolio during this vaccine-euphoric month as investors abandoned it in favor of the reopening stocks. It was seen as a pandemic stock and it performed extremely well during the bear market selloff in March. Sure, it’s a technology REIT, and technology benefitted during the pandemic. But demand for infrastructure and data centers will only grow in the future, especially with the rollout of 5G and the new technologies. This is blip for a company with a great future. It’s down about 20% from the high for no good reason. The recent selloff is a great buying opportunity. BUY
Eli Lilly and Company (LLY - yield 2.0%) – The pharmaceutical giant is down about 10% from the high in July. It’s had a downward stint on an upward trend. LLY tends to pull back and go sideways for a while and then spike higher. The firm will issue 2021 guidance next week. That could be a catalyst to get it going. It got emergency approval and the government purchased $812.5 million of its covid drug bamlanivimab. That’s what has been in the news. But the more impactful story is its best-in-class pipeline of new and future drugs. LLY should thrive when the health care sector gets moving again, which should be in the next several months. BUY
Innovative Industrial Properties (IIPR – yield 3.0%) – Innovative continues to grow like crazy as the only marijuana REIT on the market. In the third quarter both revenues and net income soared over 200% from last year’s quarter. And the sector got a shot in the arm with the election as several more states legalized marijuana. IIPR is up over 100% in less than a year since being added to the portfolio. And I still don’t think it’s time to take a profit. There could be more upside in the months ahead. The stock hasn’t pulled back after the recent upward move. It’s consolidating at the higher level. Technically, the stock still looks positive. There is a good chance that the next significant move will be to the upside. For now, it’s worth holding. Of course, if things change, we’ll take profits, but not yet. HOLD
Qualcomm Inc. (QCOM – yield 1.7%) – This chip maker stock broke out after consolidating at a higher level for several weeks. QCOM is up 10% in the last couple of weeks and spiked 5% higher in one day on reports of strong 5G wireless chip demand. While the stock benefited from the pandemic, it is well positioned for the post pandemic market when 5G becomes a bigger story. Despite the fact that the stock has returned over 90% since being added to the portfolio a little over a year ago, it still sells at about 20 times forward earnings, which is still cheap for a tech stock with strong growth in a hot area. HOLD
Realty Income (O – 4.6%) – O has historically been one of the very best income stocks on the market, and it’s still cheap after the pandemic knocked it back unjustifiably. Despite pain in certain retail areas, the vast majority of Realty’s portfolio is doing fine, and the company still grew earnings over last year in the first nine months of the year. As the pandemic inevitably fades next year, this stock is likely to come back in vogue with yield hungry investors. It’s a good price with a great dividend. BUY
Rating change “HOLD” to “BUY”
Valero Energy Corp. (VLO yield 6.6%) – It’s not where we’ve been. It’s where we’re going. This stock has been the biggest loser in the portfolio as the refining business found itself in the crosshairs of the pandemic. VLO has returned -24% since being added to the portfolio in late June of 2019. But things are turning around fast. VLO is up 65% in the last six weeks. The stock will benefit as we move to a full recovery and demand for gasoline and diesel surely increases. VLO also has a long way to go to get to pre pandemic levels. It is still 67% below the price at the end of 2019. It may bounce around in the near term, but it should surely trend higher next year if the vaccines and the full recovery come to fruition. It’s a great bet ahead of 2021. BUY
Safe Income Tier
The Safe Income tier of our portfolio holds long-term positions in high-quality stocks and other investments that generate steady income with minimal volatility and low risk. These positions are appropriate for all investors, but are meant to be held for the long term, primarily for income—don’t buy these thinking you’ll double your money in a year.
Invesco BulletShares 2021 Corporate Bond ETF (BSCL – yield 2.3%) – Sure, this short term bond ETF doesn’t provide an exciting return or a high yield. But it comes as advertised. It’s a safe port in a crazy market. While the market has been booming lately, there are still a lot of uncertainties out there. It’s nice to have something in the portfolio that you don’t have to worry about. Plus, considering the 10-year treasury still yields just 0.91%, the yield isn’t bad for safe money by today’s standards. BUY
Invesco Preferred ETF (PGX – yield 5.1%) –This preferred stock ETF is much less volatile than the stock market and provides a higher yield than all but the most aggressive bonds. It also provides diversification and preferred stock performance is historically not correlated to the stock and bond markets. It’s a great place to generate a solid yield while rounding out your portfolio. HOLD
NextEra Energy (NEE – yield 1.9%) – This is the world’s largest producer of wind and solar power. It combines this business with a rock solid regulated utility and provides a unique combination of safety and growth. Alternative energy is the wave of the future and the market loves it. Just look at the performance of some of the industry players like
Tesla (TSLA). There’s a reason beyond profitability why that stock is up 10,000% over the last ten years. NEE is a way for conservative investors to benefit from the trend. It also helps that a Biden Administration will be very friendly to the cause. Although NEE has pulled back slightly amidst the reopening euphoria, the uptrend is still intact. HOLD
Rating change “HOLD” to “BUY”
Xcel Energy (XEL – yield 2.6%) – This smaller alternative energy utility is similar to NEE but tends to mimic the same moves in a more exaggerated fashion, as it’s smaller and more aggressive. XEL has also pulled back recently amidst the vaccine rally. The stock has actually tumbled 11% in less than a month during the rally of the downtrodden. But XEL is getting cheaper ahead of what should be a splendid environment for the stock beyond the latest market rotation. Alternative energy continues to get cheaper to produce and more widely used. And the market will continue to embrace it with the excitement of a technology that will inherit the future. This is a good entry point for the stock if you don’t own it already. BUY
Two Stocks Worth Buying Today
Earlier I mentioned both the recent underperformers that have started to move as well as strong performing positions that still look strong. But there are a couple of great portfolio positions that don’t really fit into either of those categories that have moved into the BUY range, Digital Realty Income (DLR) and Xcel Energy (XEL).
Digital Realty is a REIT that specializes in technology related real estate. Specifically, it owns and operates over 270 data centers in 44 metropolitan areas across the world. It is the fifth largest REIT on the U.S. market with $3.4 in annual revenues. Its largest customers include dominant industry players including Facebook (FB), Verizon (VZ) and Oracle (ORCL).
The stock took a 15% hit recently for no good reason. It is likely just being neglected as the market focuses on stocks that benefit from the vaccine. Although DLR has been a good performer during the pandemic, the future looks bright. Technology infrastructure will continue to grow after the pandemic, especially with 5G rolling out .
Here is the estimated annual growth rate of emerging technologies; artificial intelligence (45% 2016-2025), internet of things (34% 2016-2020), autonomous vehicles (37% 2018-2025) and virtual reality (78% 2016-2022).
This is a great stock poised beautifully ahead of increasing business that has gotten cheaper.
Xcel Energy is one of the largest renewable energy providers in the U.S. with over 28% of electricity sales coming from alternative energy sources. These sources continue to become both more in demand and cheaper to produce.
The stock has consistently outperformed both the utility index and the S&P 500 over the longer term as investors seek a conservative way to play the growth of alternative energy. Like NEE, it offers defensive earnings from a regulated utility along with higher growth of an alternative energy company.
XEL has been a reliable performer through the pandemic and market recovery until recently. It took a 10% hit just because the market decided to focus on reopening stocks for now. It creates an opportunity to get into the stock that will likely be in very high demand going forward at a decent price.
Dividend 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 Dividend Investor for an explanation of how dates estimated.
The next Cabot Dividend Investor issue will be published on January 13, 2020.
Cabot Wealth Network
Publishing independent investment advice since 1970.
CEO & Chief Investment Strategist: Timothy Lutts
President & Publisher: Ed Coburn
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