October 16, 2024

Here Come Earnings

The two-year-old bull market is about to meet third-quarter earnings. And things look good.

The bull market is alive and well and shows no signs of stopping. Since the bear market low in October of 2022, the S&P 500 has risen over 60%. It has been powered by the artificial intelligence catalyst, a surprisingly resilient economy, and the peaking of interest rates. The current “soft landing” expectation means we are getting rate cuts but no economic pain. That’s good news.

Overall earnings are projected to be stronger than they have been in a couple of years. Although overall technology earnings growth is expected to slow, artificial intelligence earnings could give related stocks a boost this quarter. The market rally has broadened since July and should continue to do so with improving earnings in many sectors. An AI boost could add more fuel to a rally.

Bull markets don’t usually peter out after two years unless some event changes the math. There are still two wars and the upcoming election. But unfavorable headlines are more likely to increase volatility rather than end the bull market. It should also help the market that the Fed has begun an easing cycle that should last a couple of years.

However, the market is high, and valuations are stretched. In fact, a prominent analyst recently noted that the only other times since the 1960s that price/earnings ratios have been this high were 2021 and the dot-com bubble of the late 1990s.

That said, high valuations can persist for a long time. And bull markets rarely end because of high valuations alone. It could mean that much of the good news is already priced into the market and returns cool off for a while. A cooling off would make sense as the market is unlikely to maintain the “60% in two years” pace.

A flatter market bolsters the relative return of dividend stocks as income adds to the total return. And the portfolio is well-positioned for what likely lies ahead.

Recent Activity

October 9
Purchased Toll Brothers, Inc. (TOL) – $151

Constellation Energy Corporation (CEG) – Rating change “BUY” to “HOLD”

Alexandria Real Estate Equities, Inc. (ARE) – Rating change “BUY” to “HOLD”

High Yield Tier

AGNC Investment Corporation (AGNC – yield 13.9%) – Although this high-yielding mortgage REIT has pulled back about $0.30 per share from the high in mid-September, it has been trending higher since early August. AGNC loves falling rates, both short-term and long-term. The upside has been interrupted as better-than-expected economic numbers make it likely that interest rates won’t fall as much as hoped. But the stock is still hanging tough because the interest rate trend is with it. There are good times and bad times to own AGNC. It has been a bad time for most of the last two years. But now it looks to be in the early stages of a good time. BUY

Brookfield Infrastructure Partners (BIP – yield 4.7%) – The good times are rolling as this infrastructure behemoth just hit a new 52-week high last week. After struggling mightily for what seemed like forever, BIP has caught some fire. It was up 12.4% in September and about 40% since the middle of April. 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 slow economy or recession. BIP should have the right stuff on the right side of the interest rate cycle and with highly defensive earnings. (This security generates a K-1 form at tax time.) BUY

Enterprise Product Partners (EPD – yield 7.2%) – Although this steady midstream energy partnership has returned (between dividends and appreciation) over 15% YTD, it has been range-bound since the spring. The improving interest rate situation has reignited previously beleaguered REITs and Utilities, and those sectors have gained upward movement. Midstream energy companies are not being seen as a turnaround because they have been performing well all along. But they still have the right stuff going forward. EPD tends to be very solid in a turbulent market and should trend higher. (This security generates a K-1 form at tax time.) BUY

FS KKR Capital Corp. (FSK – yield 13.8%) – FSK is getting some strength from the strong job numbers and current perception of a solid economy going forward. It owns a portfolio of small companies that tend to be vulnerable during a recession. This ultra-high-yielding Business Development Company went ex-dividend last month and the price barely moved. When a security has a payout and yield of this size, it usually pulls back after the quarterly dividend gets priced out of the stock. But the upside momentum met that downside catalyst head-on and greatly mitigated the damage. HOLD

Main Street Capital Corporation (MAIN – yield 5.6%) – MAIN is back in business and creeping back toward the high end of its recent range as faith in the economy has grown. It took a hit in early August from the temporary recession scare but it has recovered and been trending higher since. Solid earnings and reduced recession fears are leveling the stock. The BDC reiterated its monthly dividend of $0.245 per share for the rest of the year and announced an additional $0.30 per share supplemental dividend that was paid in September. The good performance should continue if the economy stays away from a recession. HOLD

ONEOK Inc. (OKE – yield 4.1%) – This more volatile midstream energy company stock endured a sizable 5.8% one-day selloff last month. The energy sector was taking a hit and OKE had rallied strongly before then. But the stock has come roaring back, making up for all those losses and then soaring to a new high. The market loves the soon-to-be accretive acquisitions of Enlink Midstream (ENLC) and Medallion Midstream. At the same time, there could be tailwinds from an escalation of the war in the Middle East and a corresponding spike in energy prices. HOLD

The Williams Companies, Inc. (WMB – yield 3.7%) – This midstream energy company stock made yet another new high this week. Without a lot of fanfare, WMB has returned about 50% YTD. It’s also up 14% in the last three weeks. Midstream energy companies continue to outperform because they have little commodity price exposure and offer a high income in an uncertain market. Williams guided to the upper half of 2024 estimates and is still in an uptrend that began in the middle of February. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 3.2%) – True, this cutting-edge pharma company stock has leveled off and hasn’t returned anything for the past two months. But it had a big surge to a new high before then and it hasn’t pulled back. That’s encouraging. ABBV typically trades in a range and pulls back after a surge. That fact that it’s holding its ground likely means investors expect good things in future quarters. Investors are increasingly confident in the company’s ability to replace the lost Humira revenue. ABBV is getting through this year in spades ahead of greener pasters next year when management expects the company to return to “robust growth.” HOLD

American Tower Corporation (AMT – yield 2.9%) – This cell tower REIT was red-hot, but it has pulled back over the past month. AMT had been in an uptrend that lasted from May to early September, during which it rose more than 40%, but it has dropped a few percent since. A cooling-off period after such a rise is normal, especially when the REIT sector is taking a bit of a hit. It has benefited hugely and early from the REIT revival as its niche technology properties make it highly desirable. The prognosis looks bright as customers are being added to existing towers and the properties continue to expand in the U.S. and overseas. American Tower also raised guidance for 2024. BUY

Broadcom Inc. (AVGO – yield 1.2%) – This AI powerhouse was kind of bouncing around and going nowhere since the announcement of a 10-for-1 stock split in June. But it has rallied back to a new high this month. The AI trade had cooled off last quarter but it might be getting hot again. Nvidia (NVDA), a stock whose direction AVGO usually mimics, has rallied over 14% in October. The rise in chip stocks ahead of earnings is an encouraging sign that AI earnings have not slowed down and could get a big boost after the third-quarter earnings reports. BUY

Cheniere Energy, Inc. (LNG – yield 1.0%) – The stock had been bouncing around and going nowhere since mid-August, but it has gotten hot recently. LNG is up 5% in the last few weeks and broke out to a new high this week. The energy sector has been getting a bump higher in recent weeks because of the escalation of hostilities in the Middle East. Oil and gas prices are moving higher on the possibility of a large price spike because of a disruption in global supply. LNG, and just about all energy-related stocks. can live and die in the near term on the fortune of energy prices. But the longer-term trajectory should be higher as the world will continue to demand U.S. natural gas. BUY

Constellation Energy Corporation (CEG – yield 0.5%) – This nuclear energy provider finally pulled back last week after the huge spike in September. A few weeks ago, CEG had a huge one-day 22% move higher after it was announced that Microsoft (MSFT) made a deal with Constellation to buy electricity generated from a future reopening of the Three Mile Island nuclear plant in Pennsylvania. Constellation says it is the largest electricity purchase in history. The deal will add to its projected double-digit earnings growth in the years ahead. Also, the electricity demand growth and technology companies’ desire for carbon-free nuclear power are getting a lot of investor attention. Future increases in business from other big technology companies are now more likely.

CEG spiked about 40% in less than two months since being added to the portfolio. It’s also up 134% year to date. That’s a huge move in a short time. The stock may pull back after such a spike or it may hover around this price as investors anticipate more deals. But it is now beyond the ideal BUY price and is reduced to a HOLD rating. HOLD

Digital Realty Trust, Inc. (DLR – yield 3.0%) – The data center REIT pulled back along with the technology sector after mid-July. But DLR has again risen back to a new high. DLR was going strong when other REITs were struggling and now the sector is in a much better position as interest rates are likely to move lower. But the main story is the data center properties that are a high-growth business. Tech companies are forecast to invest $1 trillion in data centers over the next five years to accommodate AI. BUY

Eli Lilly and Company (LLY – yield 0.6%) – While this stud pharma stock recovered strongly from a dip in July and August, it is still stuck at the same price it was in June. But no stock goes straight up forever, and LLY has still returned over 50% YTD and over 500% since being added to the portfolio. The prognosis is still excellent as its leading weight-loss and type 2 diabetes drugs are still just near the start of their global market penetration. The company has invested $20 billion in manufacturing capacity in the last four years to meet growing demand. Analysts currently forecast 73% annual earnings growth for Lilly for the next five years. Lilly reports earnings at the end of the month and could get a boost. BUY

McKesson Corporation (MCK – yield 0.6%) – Unfortunately, supply issues with Novo Nordisk’s (NVO) weight-loss drug are a problem for this pharmaceutical supply chain company. Earnings disappointed with lower-than-expected revenues last quarter and the company cited weight-loss drug supplies that couldn’t keep up with demand as the main cause. A recent report indicates that it could be more of the same for McKesson in this quarter. The stock is way down from the high. However, it has been trending higher already in recent weeks. I’m not sure how this issue will get sorted out in the near term. But it’s a temporary problem and the longer-term prognosis for MCK is excellent. BUY

Qualcomm Inc. (QCOM – yield 2.0%) – This semiconductor-giant stock is well down from the peak in June. It is currently down 26% from the 52-week high. But the stock has leveled off over the last two months and QCOM is still up 23% YTD. Technology was getting crushed as the AI trade has been losing a lot of its luster. AI could weaken further but the AI catalyst is not going away. Qualcomm is still very well positioned ahead of the next wave of AI, which should be in mobile devices. Analysts are forecasting a strong upgrade cycle for smartphones sometime next year and QCOM can easily make up for lost time when it gets hot. Qualcomm also reports earnings in just a few weeks and could get a bump from that. BUY

Toll Brothers, Inc. (TOL – yield 0.6%) – This new-addition homebuilder company stock has been moving higher in the first week in the portfolio. The market has been solid, and the recent strong economic news is also a benefit. Mortgage rates and home prices are likely to trend lower in the quarters ahead. There is a short supply and massive pent-up demand for new homes. Sure, the market and the stock can always bounce around in the near term, but the strong trends are highly likely to result in good performance for this stock over time. BUY

UnitedHealth Group Inc. (UNH – yield 1.4%) Earnings – The health insurance behemoth stock has had a nice move higher since July. But it is stumbling this week after reporting earnings that the market didn’t like. UnitedHealth shares plunged after the company’s forecasts for 2024 and 2025 fell short of investors’ expectations. The numbers are only slightly below what was expected, and this company tends to outperform forecasts. But the company cited higher medical expenses and stricter federal reimbursement levels for the shortfall. Other stocks in the industry are falling as well. We’ll see if the negativity lasts beyond the report. BUY

Safe Income Tier

Alexandria Real Estate Equities, Inc. (ARE – yield 4.3%) – The subpar performance had gone on long enough. ARE has lagged the REIT rally. Since it was added to the portfolio in December of last year, it has only returned -5% while the sector benchmark Vanguard Real Estate Index Fund (VNQ) has returned about 11% over the same period. ARE has also been weaker than its peers recently as REITs sold down in reaction to the job numbers. The stock was downgraded to a HOLD last week. It isn’t being sold yet because there is a good chance that the market is overreacting to the jobs numbers and the sector may start to trend higher again soon. ARE has been trending higher over the last week. HOLD

NextEra Energy (NEE – yield 2.5%) – This utility that had been on fire for most of this year has been pulling back mildly in October. It makes sense. Utilities have cooled as the anticipated stronger economy is reducing the pace at which interest rates are expected to fall. Utilities are the best-performing market sector YTD and were due to cool off. But interest rates are likely to trend lower in the quarters ahead and NEE had been a market-beating superstar before inflation and rising rates. There is also growth due to anticipation of a steep acceleration in electricity demand in the years ahead. Renewable demand is expected to grow the most. BUY

USB Depository Shares (USB-PS – yield 5.1%) – The environment is still very good for fixed income despite the recent change in interest rate expectations. These securities love falling interest rates. And interest rates are at least not likely to trend higher and will probably move lower in the quarters ahead. Everything looks good for this high-yielding fixed-income security. It’s been through the worst bond market ever and now interest rates are trending down, and the price and total return are moving up. The position has returned over 32%. BUY

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.7%) – Ditto for VCLT. The long-term corporate bond ETF loves falling interest rates. The long-term bond ETF doesn’t have the upside leverage that USB-PS does. But the trend is likely to serve this security well over the next year. BUY

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