August 7, 2024

Recession Fears Take Center Stage

Monday was a bloodbath in the market. All three indexes posted massive losses. The Dow was down 2.6%, the S&P fell 3%, and the tech-heavy Nasdaq fell 3.43% on the day. The indexes recovered some of the losses on Tuesday. What can we expect going forward?

The main catalyst for the huge decline is newfound fears of recession. Those fears were primarily prompted by a much worse than expected jobs report. There were numbers within that report that have reliably portended every recession since the 1970s. But there were also bad numbers for manufacturing and construction. Suddenly, a recession, which seemed highly unlikely just days ago, has become the main issue.

Monday’s crash wasn’t just about recession though. There was some funkiness with traders borrowing money in Japan to invest in U.S. tech stocks. When Japan raised rates and tech stocks fell, the trading volatility added to the decline. There is also the expectation of an imminent attack by Iran on Israel that probably added to the negativity to some degree.

But stocks were struggling before Monday. Last week was the third straight week of declines for both the S&P and Nasdaq. The Nasdaq already fell more than 10% into correction territory before Monday. There is a growing perception technology stocks are overvalued, and earnings growth is slowing. This could be the end of the tech selloff or there will be more to come. We’ll see.

Maybe it’s an overreaction. The market was toppy and had been showing a lot of vulnerability toward negative headlines. Bull markets often tend to ignore risks for a long time and then suddenly make up for lost time and overreact. It’s certainly possible that the market will sober up in the next few days and realize that a recession may not be as likely as recent panic indicates.

But even if a recession doesn’t come anytime soon, it seems clear that the economy is slowing. Interest rates agree. The benchmark 10-year Treasury rate shoved below 4% and Wall Street has assigned a 95% chance of the Fed cutting the Fed Funds rate by 50 basis points in September. While technology performance will likely determine overall market performance, the rate declines are good news for some of the interest rate-sensitive stocks in the portfolio.

In lieu of the likely deteriorating economy, some portfolio changes are being made. Two cyclical stocks are being downgraded to “HOLD” and one is being sold. The portfolio is well diversified, but the changing landscape requires certain changes at this point.

Brookfield Infrastructure Partners (BIP), FS KKR Capital (FSK), ONEOKE (OKE), The Williams Companies (WMB), McKesson (MCK), Eli Lilly (LLY), and Qualcomm (QCOM) all report earnings later this week or next week.

Recent Activity

July 10
Purchased Cheniere Energy. Inc. (LNG) - $174.92
SOLD Marathon Petroleum Corporation (MPC) - $162.18

August 7
FS KKR Capital Corporation (FSK) – Rating change “BUY” to “HOLD”
Main Street Capital Corporation (MAIN) – Rating change “BUY” to “HOLD”
Eli Lilly and Company (LLY) – Rating change “HOLD” to “BUY”
Visa Inc. (V) – Rating change – “HOLD” to “SELL”

High Yield Tier

Brookfield Infrastructure Partners (BIP – yield 5.4%) Earnings – This great infrastructure company stock has pulled back a little amid the market tumult after a great July when it rose over 17% for the month to the highest price since last fall. Brookfield reported solid earnings last week with 10% funds from operations growth over last year’s quarter. BIP had been a stellar performer for many years prior to inflation and rising interest rates. But now interest rates are moving significantly lower and the main threat is now a recession. That’s in Brookfield’s wheelhouse as its crucial assets are highly recession-resistant. BIP held up very well in Monday’s selloff. (This security generates a K-1 form at tax time.) BUY

Enterprise Product Partners (EPD – yield 7.5%) – Even this steady midstream energy partnership is taking a hit in this market. EPD is down 9% since hitting a new 52-week high in late July. Enterprise is not leveraged to energy prices and has a recession-resistant business, but that doesn’t always matter in the near term. This midstream energy partnership reported earnings last week that were solid. It technically missed estimates by a penny, but earnings were still up 12% over last year’s quarter. The distribution is also 5% higher than a year ago and there is still an industry standout 1.6 times distribution coverage with cash flow. (This security generates a K-1 form at tax time.) BUY

Rating change “BUY” to “HOLD”

FS KKR Capital Corp. (FSK – yield 14.9%) – This ultra-high-yielding Business Development Company fell more than 7% in just a few days as recession fears exploded. It went from near the 52-week high to near the low just like that. But FSK is rebounding sharply in the market recovery, and it reports earnings this week, so it could have more near-term upside. The concern is that it deals with small companies that tend to be more vulnerable to a recession. We’ll see if this recession hysteria lasts. FSK is reduced to a HOLD rating in case the recession issue continues to gain traction. HOLD

Rating change “BUY” to “HOLD”

Main Street Capital Corporation (MAIN – yield 6.1%) – The BDC also has a lot of small business exposure, which is problematic during recessions. It was down about 8% in August before Tuesday, after having been in an uptrend since last fall. A recession would certainly change the dynamics. However, Main Street also reports earnings this week and there is a possibility the market will continue to ease off this recession business in the days ahead. But there is a high risk of circumstances shifting against this BDC and the rating will be reduced to HOLD. HOLD

ONEOK Inc. (OKE – yield 5.0%) Earnings – The natural gas midstream energy company reported earnings on Monday afternoon that crushed expectations with 28% EPS growth and 31% revenue growth over last year’s quarter. The stock soared about 4% higher on Monday morning amid a positive reaction to earnings and the market recovery from Monday’s rout. The high yield should be at a premium in a likely more sideways market going forward. It is a more volatile stock than the other midstream companies that have been in the portfolio. BUY

The Williams Companies, Inc. (WMB – yield 4.6%) Earnings – This less volatile midstream company also reported earnings this week that beat expectations and is strongly recovering from the recent weakness. WMB moves with the overall energy sector amid volatility in the near term like the other midstream stocks. Although the business is highly recession-resistant, a recession could drag the energy sector and hold back WMB. At the same time, and escalation of tensions in the Middle East could send the energy sector higher. The company also guided to the upper half of 2024 estimates. WMB is still in an uptrend that began in the middle of February. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 3.4%) – The cutting-edge pharma stock reported earnings that indicate it is weathering biosimilar competition better than expected. ABBV is up 18% over the last month to a new 52-week high and the market turbulence barely budged the stock. Newer drugs Rinvoq and Skyrizi are killing it with a combined $4 billion in revenue for the last quarter and Humira also did better than expected. AbbVie is well on track to replace the Humira revenues and return to robust profitability next year. These are challenging days and AbbVie is getting through them in great shape ahead of much greener pasters in the future. BUY

American Tower Corporation (AMT – yield 2.9%) – What market selloff? This data center REIT just made a new high. The cell tower REIT was helped by a strong earnings report last week. American Tower reported a better-than-expected 13.4% growth in adjusted funds from operations over last year’s quarter. Growth of existing cell towers is strong as new customers are being added to existing towers and the properties continue to expand in the U.S. and overseas. It also raised guidance for 2024. It surged to a nearly two-year high despite the market indexes falling and didn’t even budge during the steep Monday morning market selloff. It’s up over 32% in the last three months amid the improving interest rate outlook. BUY

Broadcom Inc. (AVGO – yield 1.5%) – I’m torn about whether to upgrade this stock to a BUY. AVGO is down over 20% from the high. It could be a rare opportunity to make it a full position at a cheap price. But technology stocks can go either way from here. I’m going to play it more cautious and hold off for now. The bet is also hedged with the BUY rating on QCOM. But it is now much closer to a realistic valuation. If the selling gets uglier, I’ll buy more as the longer-term prognosis is still spectacular. HOLD

Cheniere Energy, Inc. (LNG – yield 1.0%) – This LNG exporter has also pulled back over the last several tumultuous days after a stellar July. The energy market sector took a hit as energy prices declined on recession fears. Trouble in the energy sector is a concern going forward if there is a recession. However, the likely escalation in the Middle East war could prompt energy prices to spike higher over the next several weeks. The LNG export market adds a strong growth element that most of its peers don’t have. Cheniere reports earnings this week and can hopefully get a bump afterward. BUY

Digital Realty Trust, Inc. (DLR – yield 3.3%) – The data center REIT reported earnings that were slightly below last year’s quarter but reiterated previous full-year guidance. The market didn’t much care for the report and the stock lost a couple percent since. But more impactful than the earnings report is the selloff in the technology sector. The market is recovering from Monday’s selloff and DLR is also coming back strong. The REIT is still up 11% YTD in a tough year for REITs. Much of near-term performance will depend on whether the rout in technology is over or has more to go. BUY

Rating change “HOLD” to “BUY”

Eli Lilly and Company (LLY – yield 0.6%) – The recent market turbulence has to do with technology stocks possibly being overvalued and the increased chance of recession. But neither of those issues will affect Eli Lilly. Healthcare is the most defensive industry as people take medication regardless of the economy. Lilly also has the recently launched weight loss drug that is going gangbusters in a massive market and promises to be a mega-blockbuster. The company also has the likely approval of its Alzheimer’s drug that could also be huge. Meanwhile, LLY is down about 20% from the high after a rare pullback that is the steepest in a year and a half. Lilly reports earnings later this week and should get a bump from that as well. It’s time to add the other half position. BUY

McKesson Corporation (MCK – yield 0.5%) – After a rare pullback, the supply chain pharmaceutical company stock is right back in business. MCK made a new high last week and held up well during the selloff. MCK is still very much in an uptrend that began after the pandemic and it’s up over 30% YTD. McKesson reports earnings this week and has already indicated earnings growth of 14% to 17% for this year. The pharmaceutical supply chain Goliath dominates a market that grows all by itself because of the aging population. BUY

Qualcomm Inc. (QCOM – yield 1.7%) Earnings – The chipmaker crushed earnings forecasts for the June quarter and guided higher for the September quarter last week. But the stock fell on the day of the announcement on concerns about weaker-than-expected smartphone sales predicted for the December quarter. But the upgrade cycle is likely coming sometime next year. The recent behavior of the stock has been ugly. It’s down about 30% from the high in June, but it’s still up 15% for the year. It’s also encouraging that QCOM recovered completely from the steep Monday morning selloff in the stock later in the same day. QCOM will be volatile with the market and the technology sector in the near term, but the longer-term trajectory is still excellent. BUY

UnitedHealth Group Inc. (UNH – yield 1.5%) – The previously beleaguered healthcare insurance giant got a new lease on life. After wallowing in oblivion for seemingly forever, UNH soared about 20% since early July and made a new 52-week high. Earnings drove the stock. UnitedHealth beat earnings forecasts as it added more patients and pharmaceutical customers despite a continuing negative effect on profits from the February cyber-attack. UnitedHealth also reaffirmed previous guidance for 2024. The market is apparently happy and reassured. It’s also well positioned with all the recession talk as a highly defensive stock. BUY

Rating change – “HOLD” to “SELL”

Visa Inc. (V – yield 0.8%) – The payments processing company should be a solid holding over the longer term. But it is highly dependent on the consumer and the stock has been trending slowly lower since March. Also, the recent solid earnings report showed something behind the numbers that spooked Wall Street. Total payments volume growth slowed from 9% to 7%, marking the weakest quarter for that metric since 2020. The company said it is seeing reduced buying activity from lower-end consumers. Even if a recession is avoided, it seems clear that the economy is slowing, and the stock wasn’t performing before that was clear. The timing is bad right now for V and it will be sold. SELL

Safe Income Tier

Alexandria Real Estate Equities, Inc. (ARE – yield 4.6%) – The niche REIT held up relatively well during Monday’s market duress. But it was performing worse than its REIT peers before the market got ugly. Although earnings were basically solid and Alexandria reiterated previous guidance, it missed on revenue. However, earnings were only up 5.4% while revenues jumped 7.4%. The lease rates were solid, and Alexandria reported a healthy number of acquisitions. It stumbled after a big surge higher after the earnings report, but the defensive characteristics may serve ARE well going forward with the increased recession fears and falling interest rates. BUY

NextEra Energy (NEE – yield 2.7%) – The regulated and alternative energy utility has barely budged in this market. NEE is in an uptrend and near the 52-week high. It is a highly defensive utility, and the recession fears make NEE more desirable. NextEra forecasts revenue growth of 8.3% per year over the next three years, compared to average growth of 4.7% for the electric utility group. There is also growing anticipation of a steep acceleration in electricity demand in the years ahead prompted by onshoring of manufacturing, electric vehicle growth, and increasing data center electricity demand because of AI. Renewable demand is expected to grow the most. HOLD

USB Depository Shares (USB-PS – yield 5.6%) – It looks like interest rates are really moving lower now. The benchmark 10-year Treasury has now fallen well below 4% as fears of recession grow. It looks like the risk of rates moving higher is done. The preferred issue didn’t rise as much as it should have because of concerns about a recession. But USB stayed profitable through the pandemic and financial crisis. And this investment grade rated issue should have more upside. BUY

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 5.0%) – Ditto for VCLT. The long-term corporate bond ETF loves falling interest rates. There could be some default issues in the event of a recession, but the fund is highly diversified and will benefit greatly from lower rates as well. BUY

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