The euphoric vaccine rally has driven the market indexes to all time highs. A vaccine likely means the end of the pandemic, sooner rather than later. The removal of the remaining lockdown restrictions should unshackle the economy and bring on a full and robust recovery.
A full recovery will lift those stocks and sectors that depend on the Main Street economy. It will lift cyclical sectors like energy, finance and hospitality that had not participated in the partial recovery. It’s already happening. The losers of the earlier stock market recovery are on fire.
In this issue I highlight one of the best banks in the country. It is a highly desired stock that should be very quick to recover. The stock has strong momentum and is still priced well below the 52-week high. This issue also highlights two covered call opportunities to cash in on the market rally.
Cabot Income Advisor 1120
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Vaccine Euphoria
It’s another week and another vaccine rally for the market. For the third straight week, a company has announced positive trial results for a coronavirus vaccine. The market loves it every time. The major indexes are now at or very near all-time highs.
I don’t know if we need three vaccines. But now if any one stumbles there will be others ready to go. That increases the likelihood that a vaccine will indeed be available in the near future.
A vaccine will, theoretically, end this pandemic, and sooner rather than later. The end of the pandemic, and accompanying lockdown restrictions, will unshackle the economy and a full and robust recovery can occur next year.
A full recovery will lift those stocks and sectors that depend on a Main Street economic recovery. It will lift cyclical sectors like energy, finance and hospitality that had not participated in the partial recovery. It’s already happening. The losers of the earlier stock market recovery are on fire.
The energy, financial and industrial sectors, which have been the worst performing all year, have been by far the best performing sectors in the S&P 500 over the last three weeks. Hospitality stocks, airlines and cruise lines are flying. The financial sector is up about 15% since the first vaccine announcement on November 9. The energy sector is up over 35%.
But while the market rejoices over the end of the pandemic, the situation on the ground is getting worse. The virus is spreading and lockdown restrictions are coming back in many states. Politicians are running around canceling Thanksgiving. Why is the market celebrating while the world is going to Hell in a hand basket?
The market tends to look ahead about six months or so. It sees the pandemic on its way out by then. That vision remains regardless of what the virus does in the next month or two. So far, the deteriorating near term isn’t spoiling the market’s intermediate-term visions of glory.
We’ll see how long the euphoria lasts. But it has revived several stocks in the portfolio. Energy stocks Enterprise Product Partners (EPD) and Valero Energy (VLO) are flying. AbbVie (ABBV) and Altria (MO) have come alive. Call writing opportunities are better than they have been in months.
In this issue I identify two new covered call opportunities and highlight a new stock to buy.
What to Do Now
This market is great. But it’s also tricky here. You don’t want to sell anything while the market is still flying higher with great momentum. But it’s also tough to buy anything after prices have risen so high.
But remember, the main purpose of this advisory is to generate a high current income. We sacrifice potential appreciation for high income in the form of call premiums. And markets like this make call premiums fat and juicy, as more people are willing to speculate on higher prices in the future.
This market is creating fantastic income opportunities. It pays to write calls when the market is high and premiums are fat. It’s also possible that this market sobers up in the weeks and months ahead. There is still a lot that can go wrong.
All the stocks in the portfolio, except BGS, have been trending higher, and some sharply so. Two calls were written last week on AbbVie (ABBV) and Enterprise Product Partners (EPD) as the stocks have moved higher and near the top of the recent range. As well, there are two more calls written in this issue on Altria (MO) and the new position below.
It’s a time to hold onto the current positions and enjoy the bounty. But it’s also a great time for income investors to cash in some of the current irrational exuberance in exchange for a locked in high income.
Monthly Recap
October 28
Purchase – B&G Foods (BGS) - 26.79
November 18
Sold ABBV Dec 31 $100 call at $3.30 or higher
November 20
V Nov 20 $200 call at $10.00 or higher- Expired and called
November 23
Sold EPD Jan 15 $20 call at $0.80 or higher
Featured Action
Buy U.S. Bancorp (USB)
Yield 3.9%
Banks have been in the crosshairs of this pandemic. Interest rates crashed near all-time lows, which reduces the money they make on loans. At the same time, demand for loans fell off a cliff as the economy was shut down. As well, loan defaults spiked, as they do in any recession. It adds up to a bear market soup that caused the financial sector to be the second worst performing of the 11 S&P 500 sectors this year.
That’s the bad news. The good news is that some of the best banks in the country are still selling at cheap prices with high dividends. Plus, a full economic recovery next year will most assuredly lift bank profits and stocks, and the sector has been rallying like crazy in anticipation.
On the day of the first vaccine announcement by Pfizer (PFE) on November 9, the KBW Nasdaq Bank Index soared over 13%. The KBW Regional Bank Index jumped 16%. And those indexes have trended still higher since then. A full economic recovery ahead will lift these stocks that are still cheap in an expensive market.
But it could still be a rough road to the Promised Land. It’s possible that stock prices have gotten ahead of themselves in the near term. At this point it’s prudent to stick with the best of the best.
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-based bank was founded in 1863 and now has more than 70,000 employees and $543 billion in assets.
The bank offers a wide range of services. There are four main divisions including consumer and business real estate banking, corporate and commercial banking, wealth management services and payment services. That probably sounds more complicated than it is.
Like most regional banks, revenues are generated primarily from net interest income (NII), which is the rate spread between the cost of money and the loan interest charged to customers. Half of the loan volume is to businesses with the rest primarily from residential mortgages and personal loans. The rest of the revenue is derived from banking fees.
This is one of the best-run banks in the country with a peer-leading return on assets (ROA), return on equity (ROE) and efficiency ratios. The high level of fee income also provides a big measure of stability that other banks don’t have.
As a result, the bank is incredibly resilient. It was one of the very few banks to remain profitable during the financial crisis. This pandemic has also featured some of the worst quarters ever.
In the second quarter, despite a loss from write-offs, operational profits declined just 6%, while the GDP shrank more than 30%. The bank reported $0.99 earnings per share in the third quarter. That was lower than the year-ago quarter but revenues actually increased 2% and loan volumes rose. And that’s as bad as it got.
Meanwhile, the stock got beaten up. By late September the stock was still down over 40% from the pre-pandemic high. But the stock has moved higher by about 30% since September. It’s also 14% higher since the first vaccine announcement. Despite the recent recovery, the stock has a long way to go, still down 27% from the 52-week high. But now it has momentum and a catalyst to go higher.
As a highly desirable stock in the banking sector, USB typically fetches high call premiums. It also pays one of the highest dividend yields of all the large banks. It’s possible that USB got a little ahead of itself in the near term. But we got a taste of what likely lies ahead as the market senses the end of the pandemic.
U.S. Bancorp (USB)
Security type: Common stock
Industry: Banking
Price: $44.80
52-week range: $28.36 - $61.11
Yield: 3.9%
Profile: USB is a massive U.S. regional operator and the fifth largest bank in the country.
Positives
- A stronger recovery next year would lift bank profits and stocks.
- Operational performance has been remarkably resilient through the pandemic.
- It is one of the best banks selling at a cheap price in an out-of-favor industry.
Risks
- Interest rates remain at historically low levels.
- The virus and the vaccine remain uncertain and the recovery could get derailed.
- A Biden presidency could bring more industry regulations.
Covered Calls
Sell USB Jan 15 $45 call at $2.00 or higher
Expiration date: January 15
Strike price: 45
Call price: $2.00 or higher
The stock is very near our 45 per-share purchase price. These calls are essentially at-the-money with a strike price of 45. The idea is to generate the high call premium enabled by the recent run-up in the stock, 15% in less than three weeks. The market has had a huge run-up from the vaccine rally and is very near the all-time high. But there’s a lot that could sober it up by the middle of January. While I like this stock very much over the longer term, it could easily pull back by mid-January.
If the stock does continue to move higher, we’ll generate a 5.4% income in a short time. If it pulls back, we will keep a stock with very positive prospects in the quarters ahead and we will collect more dividends and write more calls. It’s also worth noting that this advisory had a position in USB earlier in the year and generated an 8.9% return in less than two months.
1. The stock goes above 45
- Call premium: $2.00
Dividend: $0.42 (Jan. 15)
Total: $2.42 (total income return will be 5.4% in less than two months)
2. The stock price stays the same
- Call premium: $2.00
Dividend: $0.42
Total: $2.42 (total income return will be 5.4% in less than two months)
3. The stock price declines
- You will be down by however much the stock is down less the $2.42 from the dividend and the call.
Sell MO Jan 15 $40 call at $1.90 or higher
Expiration date: January 15
Strike price: 40
Call price: $1.90 or higher
This cigarette maker stock has done little since being added to the portfolio in June. But we are still managing to milk it for a sizable income. The stock doesn’t have to really go anywhere to provide a high dividend and call premiums. Some stocks shoot higher and provide you with some capital appreciation for your troubles. Others hang around and you can keep milking them.
1. The stock goes above 40
- Call premium: $1.90
Call premium: $1.60 (exp. 7-31)
Dividend: $0.84 (June 12)
Dividend: $0.86 (Sep. 14)
Dividend: $0.86 (Jan. 9)
Appreciation: $0.34 ($40 strike price minus $39.66 purchase price)
Total: $6.40 (total return will be 16.1% in seven and a half months)
2. The stock price stays the same
- Call premium: $1.90
Call premium: $1.60
Dividend: $0.84
Dividend: $0.86
Dividend: $0.42
Total: $6.06 (total income return will be 15.3% in seven and a half months)
3. The stock price declines
- You will be down by however much the stock is down less the $6.06 from the dividends and the call. And the position will live to pay more dividends and write more calls in the future.
Portfolio Updates
AbbVie Inc. (ABBV)
Yield 5.2%
This biopharmaceutical company stock continues to trend higher. It had a big move as the threat of draconian legislation appears to have abated after the election and it’s still moving up. Insiders are continuing to buy the stock at current levels, which is a good sign. And Warren Buffett recently took a position in the stock for Berkshire Hathaway (BRK-B) as one of four pharmaceutical stocks added to the portfolio.
It broke past the old 52-week high on this latest run higher. At the top of its recent range, we wrote a covered call on the stock last week. It is the second call written on ABBV since it was added to the portfolio in June. BUY
Altria (MO)
Yield 8.6%
The cigarette maker stock is acting much better of late, along with a lot of the previous losers of this recovery. This company is in an epic battle. It has to replace shrinking cigarette volumes with other revenues. And so far the efforts have failed. In the near term Altria can gloss over the issue with price hikes and share buybacks to bolster earnings. But eventually, these other sources will have to work.
But in the near term the stock is cheap and the high dividend is secure. There isn’t much downside at this point and the high yield is real. In the meantime, we can keep collecting the dividend income and write more calls to ring the register for income on this one. BUY
Rating change: “BUY” to “HOLD”
B&G Foods, Inc. (BGS)
Yield 7.2%
The package food company hasn’t gone anywhere since it peaked in late summer. But lackluster recent performance isn’t about fundamentals. Earnings are growing more than 30% to 40% in the pandemic and promise to continue at higher than pre-pandemic levels long after the lockdowns end. But the market is seeing BGS as a pandemic trade whose time is coming to an end.
This normally stodgy high income stock has returned 55% YTD and 75% over the past year. Despite the strong recent performance the stock is still cheap and selling well below the five-year average valuation with much higher earnings and a more promising future. But Wall Street continues to shun BGS at this phase of the market. I will reduce the rating on BGS to a HOLD until it shows evidence of upward momentum. HOLD
Enterprise Product Partners (EPD)
Yield 9.4%
The seemingly endless slump in this huge midstream energy stalwart appears to be ending. After months in bear market oblivion, EPD is up over 23% in the past month as anticipation of a vaccine has given the stock new life. Unlike most energy companies, Enterprise has been holding steady and actually growing earnings in the most recent quarter of this pandemic. It never deserved to be such an outcast. But the distribution is safe and you were paid to wait. It looks like the wait is over now.
Last week a call was written on the stock at a strike price of 20 per share (currently 20.25). The stock could have more room to run or it may have gotten ahead of itself in the near term. The call guarantees that we generate a high income return from this position no matter what happens. If energy stocks continue to run higher we still have VLO. HOLD
Valero Energy (VLO)
Yield 7.8%
This refining company stock has been a tough one to own. But it looks like you will be well rewarded for the trouble. Since being added to the portfolio this past summer at 53 per share, the stock continued to bleed bad performance, and fell all the way to 38 per share. But it was a temporary overreaction. The pandemic was always going to end and the economy was always going to recover in a way that benefited Valero, as strong refined product demand must accompany any full recovery.
VLO is up over 50% since the first vaccine announcement on November 9. The prospect of a vaccine and the end of the pandemic has created a stampede into this oversold cyclical stock. It’s a great company. But right now it is a high leverage play on the end of the pandemic and a full recovery. Despite the recent performance, VLO may have a long way to go. It’s still 53% below the 2018 high and 23% below the 52-week high. BUY
Visa (V)
Yield 0.61%
This financial transaction goliath was called away at option expiration last Friday. While it’s a great company to own long term, it presented an opportunity to generate a high income in a very uncertain market. The stock was purchased on September 22 ahead of the election amidst the virus uncertainty. Because V is such a sought after stock it was one of very few conservative stocks that was generating high call premiums at the time. It was a great way to lock in a 4.9% income return in two months in a market that could have gone either way. On expiration day last Friday the stock closed very slightly above the 200 strike price at 203.88. CALLED
Call Trades
Sold V Nov 20 $200 call at $10.00 or higher- Expired and called
Total return 5.1%
$0.32 dividend (Nov. 12)
$10.00 call premium
$-0.56 capital appreciation (200.56 purchase price minus 200 strike price)
$9.76 total (income return of 4.9% in two months)
Sell ABBV Dec 31 $100 call at $3.30 or higher
Since pulling back a lot after the middle of the summer, this stock has really gotten a move on and is now at the 52-week high. The stock peaked before the pandemic and then peaked again in July. It’s now making another peak. The stock tends to move up and down on an upward trend. The stock could keep going or pull back by the expiration. Either way we win. If the stock gets called away we’ll get a 21% return since June. If not, we’ll collect more dividends and write more calls in the future.
Sell EPD Jan 15 $20 call at $0.80 or higher
It’s a tough call whether to write calls on these energy stocks at this point. They could continue to move higher or pull back after an upward spike in the midst of increasing lockdown restrictions. The portfolio has two energy stocks, so it was played down the middle. We wrote calls on EPD and we’re just holding Valero.
If energy stocks continue to run higher and EPD gets called away, we will have gotten a 20% return from a stock that’s been a dog, and we’ll still have VLO. If energy stocks pull back, we will have gotten a 9.3% income return from EPD. And energy stocks will likely surge again in the future as this pandemic will end at some point.
Income Calendar
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 December 23, 2020.
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President & Publisher: Ed Coburn
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