February 1, 2023

The Market is Improving, But It isn’t Cured

The market is doing everything it can so far this year to be unlike 2022. It’s up. And the best performing sectors are cyclical.

So far this year, the S&P 500 is up about 5% and the technology stock-heavy Nasdaq is up almost 10% in just a month. Not only are the indexes higher but they are being driven by last year’s worst performing sectors, technology and consumer discretionary.

Part of this reversal is a readjustment that often comes with an event like the turning of a calendar year. But this year’s market action is also being driven by a degree of optimism. Investors are sensing that inflation is coming down, the Fed is almost done hiking rates, and we will get through this without much economic pain.

Inflation fell to 6.5% in December from a peak of 9.1% in June. Nobody expects the Fed to ultimately raise the Fed Funds rate much beyond 5%, and it’s already 4.5%. At the same time, the economy remains resilient with 2.9% GDP growth in the fourth quarter. There is a sense that we can finally get out of the inflation/Fed conundrum with just a slower economy or perhaps a mild and quick recession.

That may turn out to be the case. I hope it is. But that seems overly optimistic. It remains unknown how sticky this inflation will be, which makes the Fed action uncertain. It also remains to be seen how deep and how long a recession might be. Worse-than-expected news on any of these fronts could send stocks reeling again.

It’s too early to buy into this rally and the optimistic posture of the recent market. There is still risk of further downside and a sustained turnaround is unlikely until there is more clarity on inflation, the Fed, and the timing of an economic turnaround.

For those reasons, the CDI portfolio remains conservatively postured with mostly defensive stocks, a high cash allocation, and new fixed income positions.

Recent Activity

January 11
Purchased Vanguard Long-Term Corp. Bond Fund (VCLT) - $80.35

January 25
Medical Properties Trust (MPW) – Rating change “HOLD” to “BUY”
Xcel Energy (XEL) – Rating change “BUY” to “HOLD”

Current Allocation
Stocks 32.5%
Fixed Income 20%
Cash 47.5%

High Yield Tier

Enterprise Product Partners (EPD – yield 7.4%) – It’s another good year so far for the midstream energy partnership. It’s up over 8% so far in January after returning a market-shellacking 18.4% in 2022. Of course, it hasn’t been lighting the world on fire but it doesn’t have to while paying you a whopping 7.4% per year just to hold it. EPD is also well positioned for possible perils ahead in 2023 as it can continue to generate solid profits in recession and/or inflation. (This security generates a K-1 form at tax time). BUY

ONEOK Inc. (OKE – yield 5.6%) – This midstream energy company has been pulling back in recent weeks after breaking out above the recent range to near the 52-week high. It’s mostly a consequence of the market rally losing traction. But OKE remains very well positioned going forward. Natural gas demand should remain steady even in a recession as supply constraints continue to cause problems in Europe and Asia. Revenues should be steady even in a recession and the stock price is still below the pre-pandemic high and earnings are much higher now. BUY

Realty Income (O – yield 4.4%) – The legendary income REIT isn’t exciting, but it tends to deliver as advertised over time. O has delivered a positive return over the last year in a down market. It also returned 10% over the last three months and has finally overtaken the elusive 65 per share level. Hopefully, O can keep running. It’s a popular and defensive income stock that should hold its own in the event of a recession. BUY

The Williams Companies, Inc. (WMB – yield 5.4%) – WMB has been a big laggard in the midstream energy space in recent months. It held up much better than its peers when the sector took a hit in the fall. But it has foundered in the sector recovery. The market seems to like its defensive characteristics best and it tends to rally with the more defensive plays. And defensive stocks may come back again in a big way before long. Prospects for midstream companies and stocks this year remain excellent. The company posted strong earnings last quarter because of resilient natural gas demand. BUY

Medical Properties Trust, Inc. (MPW – yield 8.9%) – This high-paying and recession -esistant hospital REIT has pulled back a little the past couple of weeks after rallying strongly in the first half of January. But the stock remains in a technical uptrend that began in October. The dividend is safe, and the operational performance of the company is solid, with better than 30% earnings growth last quarter. MPW is dirt cheap with a high yield and a recession-resistant business. This should be a good year. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 4.1%) – It’s been a weird year in the market so far. All of the 50 worst-performing stocks on the S&P 500 in 2022 are up so far this year. It has been a reversal of last year’s situation and healthcare has gone from one of the best-performing sectors last to one of the worst so far this year. But this January dynamic may not last. Defensive stocks will again be better relative performers if the market turns south again. And ABBV has some powerful longer-term factors going for it. HOLD

Broadcom Inc. (AVGO – yield 3.2%) – Sure, technology stocks have performed much better lately. But this software and chip company goliath has been trending consistently higher since October. It’s made a very big move and is up about 40% from the low. Its fortunes are tied to the technology sector, but it has done a lot better than its peers in the tough market. That could be because Broadcom reported 21% revenue growth and a 34% earnings increase over last year in the latest quarter. HOLD

Brookfield Infrastructure Partners (BIP – yield 4.1%) – The infrastructure juggernaut has reawakened after a rough patch where the rising dollar held it back. BIP is up about 14% YTD. The dollar strength was priced into the stock and the greenback is weakening and likely to weaken further as the Fed lightens up on the rate hikes. Meanwhile, investors are realizing that BIP is a terrific recession stock because of the crucial nature of its assets and the defensive and consistent revenue they generate. (This security generates a K-1 form at tax time). BUY

Eli Lilly and Company (LLY – yield 1.3%) – LLY is pulling back a little after a phenomenal 2022 when it returned 34% in a bear market. LLY is down 7% in the last month. The main reason is that healthcare and other defensive stocks have been down as cyclical stocks have soared in the recent rally. But Lilly also had some bad news. Its Alzheimer’s drug was denied fast-track approval. The reason was because of some data discrepancy and not bad trial results and the stock only fell around 2% on the news. It delays approval but doesn’t change the story. HOLD

Intel Corporation (INTC – yield 5.2%) – The already beleaguered chip stock got another black eye this past week. Revenues plunged 32% for the quarter versus the prior year and demand for PC and server chips is falling. Global PC (personal computer) shipments fell 28.5% in the quarter. It’s the slowing economy but also some comeuppance for the abnormally high demand during the pandemic. Intel also said next quarter will be worse. The good news is that the company is employing a massive cost-cutting program and new products should also help the bottom line in the second half of this year. HOLD

Qualcomm Inc. (QCOM – yield 2.3%) – QCOM has been kicking butt. Sure, technology stocks are up. But QCOM is up more. It’s up 20% so far this month, more than twice the YTD return of the sector. It has also cracked the 130 per share level for the first time since September. It got a big upgrade when Barclays came out with a very positive report last week. The analyst said that the worst is over for chip stocks and QCOM should be among the first in the sector to rebound. Before long, the market, which tends to anticipate six to nine months ahead, may start pricing in a real recovery in the sector. HOLD

Visa Inc. (V – yield 0.8%) – The payments processing company stock has been thriving. After a mere -3.4% loss in last year’s bear market, V is up over 10% YTD. Even if the recent cyclical rally ends, V should continue to hold up relatively well and it is giving a preview of how well it will react when the market finally turns for good. It’s well worth holding through the uncertainty into the next recovery. HOLD

Safe Income Tier

NextEra Energy (NEE – yield 2.1%) – Utilities were riding high in the market tumult. But now the sector is taking a back seat in the recent rally as last year’s downtrodden stocks have come alive. The latest rally has been one in which defensive stocks and last year’s winners are out, and the losers are back in. But that dynamic is unlikely to be sustained as the economy continues to slow and investors realize it might be a longer slog to the next true recovery. The recent downturn provides a good entry point for NEE ahead of a period of historic outperformance for utility stocks. BUY

Xcel Energy (XEL – yield 2.8%) – This clean energy utility stock had been a superstar when the sector was hot. It is now understandably cooling off. It has pulled back more than 7% from the recent high earlier this month after rallying sharply late last year. This stock tends to be bouncy and would be very much in character for it to fall further on the current down move. For that reason, it was downgraded to a HOLD last week. I still like XEL over the rest of the year and will likely upgrade the rating when the stock breaks the downward trend. HOLD

USB Depository Shares (USB-PS – yield 5.4%) – So far, it has been a great move to lock in this high fixed rate yield when rates were near the high. The price has appreciated, and the position has returned 15% in the past couple of months. Locking in the high rates may turn out to be a good longer-term move as well. BUY

Invesco Preferred ETF (PGX – yield 6.3%) – Ditto what I said about USB-PS. Longer-term rates are coming down as the economy slows. And most economists are predicting a recession next year and investors have been flocking toward fixed income. This provides diversification from stocks with a high income ahead of a period when interest rates could fall back. BUY

Vanguard Long-Term Corp. Bond Index Fund (VCLT – yield 4.4) – The same interest rate story for the last two positions above applies here. The timing is probably good to lock in higher rates on investment grade bonds ahead of a likely recession. BUY