In This Issue
Financial Stocks Have the Right Stuff in a Shifting Market
Cyclical stocks are hot and technology stocks are not. Wait a minute. Cyclical stocks are moving lower and technology is roaring back. That’s been the story over the past month.
Of course, energy stocks are due for a pullback or consolidation after such a huge move higher. It’s normal. And the prognosis for the sector is still good for the rest of the year. It also isn’t clear if technology stocks are finished correcting or not. While those sectors are having all the fun, most S&P 500 sectors haven’t been doing much.
Some of the more defensive sectors like utilities, REITs and health care have been neglected during the market’s recent cyclical stock bender. There are some bargains in those sectors. But it’s difficult to see where the market goes next.
The cyclical rally could well continue ahead of what is likely to be a booming economy with trillions in stimulus and still-low interest rates. Technology stocks could reassert their dominance as the technological revolution continues and that’s where most of the growth is. At the same time, defensive stocks are overdue for a rally.
While it’s tough to gauge the next leg of the market, I believe that financial stocks are best positioned in the near term as well as for the rest of the year. They offer a complete package of value, momentum and position in the economic cycle.
Despite the recent move higher, the Financial Select Sector SPDR Fund (XLF) just recently eclipsed the highs from before the financial crisis. It took the sector more than 13 years to recover. And many stocks in the sector still sell at valuations far lower than the overall market.
At the same time, financial stocks tend to thrive in the early stages of an economic cycle, which is where we are now. Financial companies also love rising interest rates. The benchmark 10-year Treasury yield has already risen to 1.65% from just 1.1% at the beginning of February.
The rate had averaged between 2% and 3% in the years before the pandemic. And we are in a year that most economists are saying will provide the fastest GDP growth in decades. That growth will combine with trillions in stimulus floating around. It’s hard to see how the 10-year Treasury rate doesn’t at least get back to where it was before the pandemic.
While the financial sector has been the second-best performing sector on the S&P YTD, it isn’t as overextended as energy. It’s only up about half as much so far this year.
In this issue I highlight two financial stocks for purchase. These stocks offer good value like most of the other positions currently in the portfolio. But they also offer more near-term momentum to boot.
What to Do Now
It’s been an unusual market, and a little deceiving. A look at the S&P 500 shows a market that simply continues to forge ever higher with little interruption since the fall. But there is a lot more going on under the hood than the one-year chart indicates.
Technology stocks drove this bull market until fairly recently. But for the past several months, cyclical or Main Street economy stocks in energy and finance have taken the reigns and powered the index higher. In the past month, the shifting leadership has been more volatile.
Technology stocks fell 10% into correction territory while cyclical stocks made up the slack and surged even faster. Then, cyclical stocks have been pulling back as technology stocks recovery. Yet all the while, the S&P 500 looks like smooth sailing.
At this point, it isn’t entirely clear if technology stocks are done correcting. It also remains to be seen if energy stocks are in the midst of a minor blip or a more significant consolidation after a torrid run higher. Time will tell. But it makes sense to tread lightly in those sectors for now.
While technology and cyclical stocks have provided all the excitement, most of the S&P 500 sectors haven’t done much of anything. The stocks have sort of been moving sideways while those other sectors take center stage. The situation has provided some good buying opportunities in under-the-radar stocks.
This portfolio has been buying those stocks over the past few months. As the market changes, several of those recently neglected shares should move higher and create good call writing opportunities. Outside of energy, it has been a better environment to buy shares than write calls. But I expect that to change in the weeks and months ahead.
We took advantage of the high call premiums in energy stocks as that sector gained traction, and shares of Valero Energy (VLO) and Chevron (CVX) are likely to be called as those options expire in the next week and a half.
Buy 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 3,000 bank branches in 25 states in the western and northern U.S. The Minneapolis bank was founded in 1863 and now has more than 70,000 employees and $543 billion in assets.
We have owned USB on two separate occasions in this portfolio. Both times we wrote calls on the position and the stock was called away. But both positions were very profitable and provided a high level of income in a short time. The first time the portfolio got a total return of 8.24% in a little less than two months. The second time provided a total return of 6.2% in about six weeks.
We already got a 14.44% return on USB so far since July. But here we are buying it again at a higher price than it was called last time. Owning the same stock several times is fine as long as the stock can be milked for a solid income return. This is a conservative stock in a sector that is likely to trend higher over the course of the year and we should be able to derive a high income without taking too much risk.
Regional banks are highly dependent on net interest income, the spread earned between the cost of borrowing money and the loan rate charged. Banks borrow at short-term rates set by the Fed that are likely to remain near 0% for the foreseeable future. At the same time, longer-term rates are rising and should continue to rise as the recovery gains traction. The steepening yield curve is great for banks.
The stock is also cheap. Although USB is up about 16% YTD, it still sells below the pre-pandemic price ahead of an environment that is likely to be much better for banks. It also sells at valuations well below the overall market.
But its mostly about the trend. USB has been trending higher since last September. The early part of a recovery is a great time for banks and financial companies and USB should continue to thrive into the full recovery later this year.
Not only does USB still sell at a compelling valuation, but it has momentum. Momentum boosts the level of call premiums.
Buy KKR & Co. Inc. (KKR)
KKR & Co. (KKR), Formerly Kohlberg Kravis Roberts Co., is a leading global alternative asset manager. The firm manages multiple alternative asset classes including private equity, energy, infrastructure, real estate, credit, as well as hedge funds through strategic partners. It generates revenues from management fees, performance income and investment income with a global reach on five continents.
A booming economy and rising interest rates are a great environment for financial companies. The rest of this year should be very good for the sector. But KKR is also the best player in a massive growth trend in the wealth management industry. Alternative investment is a longer-term trend.
Basically, alternative assets are those that do not fall within the realm of traditional stock and bond market investments. In the world of high finance, these assets include areas such as private equity and hedge funds among other things.
These investments are growing like crazy. Global alternative asset investments have grown from $6.4 trillion in 2012 to about $14 trillion in 2020. It is estimated that alternative assets worldwide will continue to grow to more than $21 trillion by 2025.
There’s a good common-sense reason for the growth. Consider your own investment situation. Bonds are low-paying and treacherous. The only place to fetch a decent return is the stock market. But it’s risky to have a huge portion of your nest egg in the market.
It’s an even bigger problem for high-net-worth individuals, and most especially for institutions like pension and endowment funds with fiduciary responsibility. They need to manage risk and diversify away from the market and get a decent return at the same time. Alternative assets are just what the doctor ordered.
I consider KKR to be the best of its peers in the sector. It has blown away the return of its competitors over the past five years, averaging an annual return of 35.86% over the last five years and 36% over the last three. And there are good reasons to believe the outperformance will continue.
KKR had an all-time record fundraising year in 2020, bringing in $44 billion in assets under management for the year. A record $12.5 billion was deployed, or invested, in the fourth quarter. And the firm still has plenty of dry powder going forward.
KKR also made a huge $4.4 billion investment in Global Atlantic Financial Group (GA), a huge player in the insurance industry. The firm’s growth rates have been even more impressive than KKR’s over the past five years and the acquisition could be a needle-mover going forward.
Despite the recent stellar performance, KKR still sells at a price/earnings ratio of less than 14 times. That’s well below the five-year average and less than half of the current S&P 500 price earnings ratio.
The stock has moved sideways for the last six weeks after a big surge and could be consolidating ahead of another move higher in the weeks ahead.
|CIA STOCK PORTFOLIO|
|Open Recommendations||Ticker Symbol||Entry Date||Entry Price||Price on
|Buy at or
|AGNC Investment Corp.||AGNC||01/13/21||15.52||16.52||17.00||8.68%||9.04%|
|Digital Realty Trust||DLR||1/27/21||149.17||139.44||155.00||3.40%||-7.67%|
|Valero Energy Corp.||VLO||8/26/20||53.70||70.05||60.00||5.42%||39.10%|
|NextEra Energy, inc.||NEE||2/24/21||73.76||73.78||80.00||2.15%||-2.30%|
|KKR & Co.||KKR||New||—||47.82||50.00||1.19%||—|
|EXISTING CALL TRADES|
|Open Recommendations||Ticker Symbol||Intial
|Buy Under or
Sell Down To
|VLO Mar 26 $60 call||VLO210326C00060000||Sell||2/10/21||6.50||11.90||6.50||12.10%|
|CVX Apr 1 $95.50 call||CVX210401C00095500||Sell||2/19/21||4.30||5.55||4.30||5.02%|
|As of Close on 3/22/21|
|Security||Ticker Symbol||Action||Entry Date||Entry
|Sale Date||Sale Price||Total Return|
|Innovative Industrial Props.||IIPR||Called||6/2/20||87.82||9/18/20||100.00||15.08%|
|Brookfield Infras. Ptnrs.||BIP||Called||6/24/20||41.92||10/16/20||45.00||8.49%|
|Enterprise Prod. Prtnrs.||EPD||Called||6/24/20||18.14||1/15/21||20.00||15.16%|
|B&G Foods Inc,||BGS||Called||10/28/20||26.79||2/19/21||28.00||4.42%|
|Security||In/out money||Sell Date||Sell Price||Exp. Date||$ Return||Total % Return|
|IIPR Jul 17 $95 call||out-of money||6/3/20||3.00||7/17/20||3.00||3.40%|
|MO Jul 31 $42 call||out-of-money||6/17/20||1.60||7/31/20||1.60||4.03%|
|ABBV Sep 18 $100 call||out-of-money||7/15/20||4.60||9/18/20||4.60||5.05%|
|IIPR Sep 18 $100 call||in-the-money||7/22/20||5.00||9/18/20||5.00||5.69%|
|QCOM Sep 18 $95 call||in-the-money||6/24/20||4.30||9/18/20||4.30||4.82%|
|USB Sep 18 $37.50 call||in-the-money||7/22/20||2.00||9/18/20||2.00||5.52%|
|BIP Oct 16 $45 call||in-the-money||9/2/20||1.95||10/16/20||1.95||4.65%|
|SBUX Oct 16 $87.50 call||in-the-money||10/16/20||3.30||10/16/20||3.30||4.00%|
|V Nov 20 $200 call||in-the-money||9/22/20||10.00||11/20/20||10.00||4.99%|
|ABBV Dec 31 $100 call||in-the-money||11/18/20||3.30||12/31/20||3.30||3.62%|
|EPD Jan 15 $20 call||in-the-money||11/23/20||0.80||1/15/21||0.80||4.41%|
|MO Jan 15 $40 call||in-the-money||11/25/20||1.90||1/15/21||1.90||4.79%|
|USB Jan 15 $45 call||in-the-money||11/25/20||2.00||1/15/21||2.00||4.48%|
|BGS Feb 19 $27.50 call||in-the-money||12/11/20||2.40||2/19/21||2.40||8.96%|
AGNC Investment Corp. (AGNC)
The timing is exquisite. This mortgage REIT thrives during times of a steepening yield curve, as its net interest margins expand, and profitability grows. This early-stage recovery environment is ideal. Despite the great timing and upward momentum, AGNC still sells at valuations below the five-year averages. It checks every box. It is worth waiting for a higher price to write calls and assure a high total return. In the meantime, the stock has a huge annual yield and pays out every month. BUY
Brookfield Infrastructure Partners (BIP)
Some day in the not-too-distant future, BIP will break out to higher price level. When that day comes, we will be right there to write high priced calls and assure a high income and likely high total return. BIP has been bouncing around and getting nowhere for months now. It’s a defensive income stock holding its own while investors neglect such plays and slobber all over cyclical stocks. But it is well positioned for a great year. Profits should soar as cyclical areas in transportation and energy rebound. New assets purchased on the cheap last year will come online and boost earnings. And infrastructure will likely be an increasingly popular subsector as Washington increased the focus. BUY
Chevron Corp. (CVX)
This best-in-class energy giant went up less than the overall energy sector during the torrid rally. And now, it’s pulling back less than the sector during this consolidation. The recent energy stock surge had to take a breather at some point. That’s normal and healthy. But I still think the sector in general and CVX in particular has a lot more upside left in the tank for the remainder of the year. The stock is still below the pre-pandemic price ahead of an environment that is likely to be a lot better. In the near term, CVX continues to be under pressure, but we’ll see if it falls below the strike price for the calls written (95.50) by expiration on April 1. HOLD
Digital Realty Trust, Inc. (DLR)
I believe this stock will take off at some point. It tends to bounce around on a longer-term upward trajectory. But that pattern got exaggerated over the past year. It flew high as technology thrived during the pandemic. But, as a REIT and pandemic beneficiary, it got neglected as previously downtrodden cyclical stocks thrived. DLR is at an exaggerated low point in an up and down patter that shouldn’t last. It’s a huge player in the growing data center business. When the market changes stripes, it should like this one a lot better. BUY
Enterprise Product Partners (EPD)
This midstream energy giant is resilient and perfectly positioned in the current environment. It got clobbered with the rest of the energy sector during the pandemic as oil and gas demand fell off a cliff. But Enterprise didn’t take nearly the hit to business that most energy companies took, as earnings were only off about 10% in 2020. Now, it’s lagged in the energy rebound because profits aren’t rising as fast as most of the sector. This fee-based company that pipes and stores oil and gas should benefit over the rest of the year as the energy rally sobers up and becomes more selective. This is still an excellent buy point. EPD offers great value, rising earnings, momentum and a high and safe distribution. BUY
NextEra Energy Inc, (NEE)
I believe we got into this regulated and alternative energy utility at a cheap price amidst a rare dip. Investors love the combination of stable earnings and exposure to the high-growth clean energy business. NEE had long been an up-trending juggernaut, until it finally ran into a market phase that didn’t like it. As the market inevitably changes its personality in the weeks and months ahead, NEE will likely come back into vogue. It’s defensive and a conservative way to play the exciting growth in alternative energy. BUY
Valero Energy (VLO)
This refiner and high-leverage play on a full recovery exaggerated the move of the energy sector on the upside, and now its doing the same thing on the downside. After a torrid 50% rise in about six weeks, VLO has pulled back 14% so far in the last ten days. A consolidation was bound to happen, and the stock should have lot more upside over the remainder of the year. But VLO is still priced more than 10 per share above the strike price for the calls that expire on Friday. It’s highly unlikely to fall that much in just a few days and the shares will likely be called if you sold calls. BUY
Existing Call Trades
VLO March 26 $60 call at $6.50 or better
With just a few days left until options expiration and the stock selling at 10 per share above the strike price, the shares will almost certainly be called. The stock price exploded and rose 50% in six weeks. But the position will yield a huge 27.4% total return between the dividends, the call premium and price appreciation in a relatively short amount of time.
- Call premium: $6.50
Dividend: $0.98 (paid Dec. 9)
Dividend: $0.98 (pays Mar. 4)
Appreciation: $6.30 ($60 strike price minus $53.70 purchase price)
- Total: $14.76 (total return of 27.4% in seven months)
CVX April 1 $95.50 call at $4.30 or better
CVX also took off in the recent rally and is pulling back recently. But these calls still have 10 days left until expiration and the stock is only 6 per share or 6.3% above the strike price. If energy stock prices continue to consolidate it is very possible that CVX closes below the strike price on expiration and shares are not called. However, it is still most likely that shares will be called. We’ll see.
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 April 28, 2021.
Cabot Wealth Network
Publishing independent investment advice since 1970.
President & CEO: Ed Coburn
Chairman & Chief Investment Strategist: Timothy Lutts
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