September 25, 2024

Rate Cuts and No Recession, for Now

The market is hot stuff again. The S&P made a new high this week after making up all the early September losses and then some. It is the 40^th record close for the index, which is now up 20% YTD with another quarter left.

The rate cut finally arrived. After nearly two years of the highest interest rates in decades, the Fed has begun to cut. The rate cut was at the higher end of expectations, 50 basis points. While investors will fret about the pace and scope of future cuts, the cutting cycle has begun, and it will continue for the next two years.

Amid the rate cut euphoria, investors increasingly expect a “soft landing.” It looks like we’ll get falling interest rates without the requisite economic pain. Recession fears are so early August. But while a soft landing is entirely possible, it isn’t a done deal. Things can turn fast. Currently jubilant investors will cry doom again with the next lousy economic number.

The economy isn’t the only risk either. There is no end in sight to the two wars, and things could escalate. A very contentious election is now just weeks away. We’ll see how the market navigates this minefield.

With the market at a high and uncertainties abounding, the safer stocks look like a prudent bet. These stocks have come alive recently with the improving interest rate narrative. They are still cheap, after years of underperformance, as well as high yielding, and now have good momentum.

This new Fed era has been anticipated. The best-performing of the eleven S&P 500 stock sectors for the past three months are Real Estate and Utilities. The worst-performing sectors last year are among the best-performing this year. Current portfolio positions at or near the 52-week high include utility stocks Brookfield Infrastructure Partners (BIP), Constellation Energy (CEG), and NextEra Energy (NEE) as well as REITs Digital Realty Trust (DLR) and American Tower Corp. (AMT).

Recent Activity

August 28
Qualcomm (QCOM) – add 2/3 to position - $171.85

September 11
Purchased AGNC Investment Corp. (AGNC) - $10.18

Broadcom Inc. (AVGO) – Rating Change “HOLD” to “BUY” and add ½ position - $158.27

ONEOK Inc. (OKE) – Rating change “BUY” to “HOLD”

AbbVie (ABBV) – Rating change “BUY” to “SELL 1/2” - $194.59

NextEra Energy (NEE) – Rating Change “HOLD” to “BUY”

High Yield Tier

AGNC Investment Corp. (AGNC – yield 13.9%) – This new high-yielding mortgage REIT has been trending higher since the beginning of July. It also had a spike in September before pulling back a little this past week. The writing should be on the wall for an upside move in this mortgage REIT. Short-term rates are officially coming down and will continue to do so for the next two years, lowering costs and increasing margins. Longer rates are also likely to continue trending lower, which should boost the book value of the portfolio and the stock price. 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 4.8%) – The good times are rolling as this infrastructure behemoth just hit a new 52-week high. After struggling mightily for what seemed like forever, BIP has caught some fire. It’s up 8.4% in September and 39% 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. That’s in Brookfield’s wheelhouse as its crucial assets are highly recession-resistant. (This security generates a K-1 form at tax time.) BUY

Enterprise Product Partners (EPD – yield 7.1%) – Although this steady midstream energy partnership has returned (between dividends and appreciation) over 17% YTD, it has been rangebound since the spring. The improving interest rate situation has reignited previously beleaguered REITs and utilities, and those sectors have gotten most of the love. 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 as more investors opt for dependable income in the increasingly volatile market. (This security generates a K-1 form at tax time.) BUY

FS KKR Capital Corp. (FSK – yield 14.2%) – This ultra-high-yielding Business Development Company went ex-dividend earlier this 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. While recession is still on the radar, it might be a long way off and that huge payout from FSK should be highly desirable in a more sideways market over the next few months. HOLD

Main Street Capital Corporation (MAIN – yield 5.8%) – MAIN took a hit in early August from the temporary recession scare, but it has recovered and has been trending higher since. Plus, it barely budged in the down market in the first week of September. A recession would certainly change the dynamics. However, 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 payable in September. HOLD

ONEOK Inc. (OKE – yield 4.2%) – The prognosis for this midstream energy company changed for the better earlier this month. ONEOK announced $5.9 billion in acquisitions of two companies, pipeline company Enlink Midstream (ENLC) and Medallion Midstream. The deals are expected to close in the fourth quarter and be accretive to earnings immediately. The company conservatively expects a 5% jump in earnings and a 15% increase in cash flow through 2028. It greatly adds presence in the high-growth Permian Basin and adds predictable fee-based business. The market likes the deal as OKE has been making new all-time highs and the stock is up over 38% YTD. HOLD

The Williams Companies, Inc. (WMB – yield 4.1%) – This midstream energy company stock is quietly kicking butt while energy has been the worst-performing S&P sector YTD and interest rate-sensitive stocks have been getting all the attention. WMB just hit a new 52-week high this week and has returned over 35% YTD. 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. WMB is still in an uptrend that began in the middle of February. BUY

Dividend Growth Tier

AbbVie (ABBV – yield 3.2%) – One-half of the position of this cutting-edge pharma company stock was sold earlier this month because it has a long track record of pulling back after surges like it just had, up 28% since the end of May. But the company is operationally solid. This was supposed to be a tough year with falling revenues from the Humira patent expiration. But investors are impressed that newer drugs Rinvoq and Skyrizi are killing it and are increasingly confident of 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 2.7%) – The cell tower REIT has been basically killing it since the middle of April. It has soared over 39% since then. It has benefited hugely and early from the REIT revival as its niche technology properties make it highly desirable. AMT is now near the highest level in about two years. 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 has bounced around since its stellar earnings report and announcement of a 10-for-1 stock split in June. AVGO was upgraded earlier this month, and the other one-half position was added back after the stock took a beating in the beginning of this month. The AI trade has lost a lot of luster recently. The eventual slowdown was inevitable. But AI is still a huge catalyst, and the market phenomenon is far from over. Broadcom is one of the best-positioned companies, and the stock can easily make up for lost time when it gets hot again. BUY

Cheniere Energy, Inc. (LNG – yield 1.0%) – This natural gas exporter took a hit early in September as the market reeled and the energy sector struggled. But it has bounced back nicely. Natural gas prices have been falling and the overall energy sector doesn’t behave well when that happens. But that isn’t necessarily a bad thing for Cheniere as the spread between U.S. and overseas prices remains high. The world still needs U.S. natural gas. Although the price can bounce around with gas prices in the near term, NGL exports continue to grow. BUY

Constellation Energy Corporation (CEG – yield 0.6%) – WOW! It was announced last Friday 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. CEG soared over 22% higher the day of the announcement. Details of the agreement are yet to be released, but management at Constellation says it is the largest electricity purchase in history. It should add to Constellation’s already projected double-digit earnings growth over the next several years. The deal also confirms the fact that technology companies, which are responsible for the surge in electricity demand, are targeting carbon-free nuclear power. Future increases in business from other big technology companies are now quite likely. BUY

Digital Realty Trust, Inc. (DLR – yield 3.0%) – The data center REIT pulled back along with the technology sector after mid-July. But it’s up over 9% in September and made a new 52-week high this week. 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%) – The pharma superstar stock has been bouncing around near the high point of the recent range for over a month. It recovered sharply from a pullback this summer after another blowout earnings report. Sure, LLY has been a little stuck in the mud recently, but it is encouraging that it isn’t really pulling back despite being up over 58% YTD. LLY has been held back by supply concerns for its weight-loss drug because Novo Nordisk A/S (NVO) is experiencing shortages. But Lilly is reporting an easing of supply constraints. Novo had supply problems last quarter and Lilly didn’t. BUY

McKesson Corporation (MCK – yield 0.6%) – Unfortunately, the Novo supply issues mentioned above are a bigger 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. The recent report indicates that it could be more of the same for McKesson in this quarter. The stock is down 22% from the high. 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. This is a good buying opportunity if you don’t already own the stock. BUY

Qualcomm Inc. (QCOM – yield 2.0%) – This semiconductor giant has certainly taken some lumps in recent months. It sold off in the first week of this month but has since recovered. But the stock is still down 28% from the high made in mid-June. 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. BUY

UnitedHealth Group Inc. (UNH – yield 1.5%) – The health insurance behemoth started the month off hot while the rest of the market was getting crushed. But as the market recovered UNH pulled back slightly. It seems to be a stock in higher demand when the market gets ugly because it’s defensive. UNH is a good hedge in case the market struggles and/or a recession becomes more likely. UnitedHealth beat earnings forecasts last quarter 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. It’s well positioned in a slowing economy as a highly defensive stock. BUY

Safe Income Tier

Alexandria Real Estate Equities, Inc. (ARE – yield 4.3%) – The performance of this life science property REIT has been uninspiring. ARE had a strong surge at the end of last year but it has been rangebound and sideways all year. Since it was added to the portfolio in December of last year, it has only returned -3.48% while the sector benchmark Vanguard Real Estate Index Fund (VNQ) has returned about 14% over the same period. The fundamentals of the business seem to be solid. I’ll wait and see what happens over the next month after the Fed rate cut and the improved interest rate narrative. Hopefully, the good interest rate news and its defensive characteristics in a slowing economy are enough to get ARE moving higher. BUY

NextEra Energy (NEE – yield 2.4%) – This utility has come alive again after a couple of years of subpar performance. Of course, utilities are back in favor but the resurgence of NEE predates the sector turnaround which began about three months ago. NEE is up 19% since the end of June and 52% since the end of February. NEE had been a market-beating superstar before inflation and rising rates and appears to be returning to form as that situation reverses. 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 5.0%) – The environment is getting brighter and brighter for fixed income. These securities love falling interest rates. 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 33% now. BUY

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.9%) – 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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