We are in the late stages of a recovery and bull market. The economy is still strong and the bull market could continue for a while. But the escalation of trade frictions with China is disrupting the situation.
Since the trade war escalated a month ago, the market has fallen every week since. And things might get worse before they get better. The trade war takes a small toll on the economy but it hurts the global economy much more. A faltering global economy would come back and bite us, and perhaps draw the next recession closer.
With no catalyst in sight to fix the current situation and a recession looming somewhere in the not-too-distant future, it makes sense to play defense. Defensive dividend paying stocks are the stars of the market now and may continue to be for a long while.
In this issue I highlight one of the very best defensive dividend stocks on the market. It has rock solid earnings in any environment and the stock should perform well in just about any market.
Cabot Dividend Investor 819
[premium_html_toc post_id="185344"]
Defense is the Best Offer
Here we are in the tenth year of an economic recovery and bull market. All recoveries end in recession and all bull markets end in bear markets. Both have already well exceeded the average historical life spans. In fact, this is now officially the longest recovery and bull market on record, ever.
That said, the economy is still solid. There is still no sign of recession in the foreseeable future, and most bear markets coincide with recessions. This late stage strong economy could last quite a while longer. But things are being interrupted. The market just got a dose of exactly what it didn’t want to hear, an escalation of the trade war with China.
About a month ago President Trump announced sanctions on an additional $200 billion of Chinese imports. China responded by banning the purchase of U.S. agricultural exports and devaluing its currency. The market indexes have closed lower every week for the four weeks since.
Last week, China announced additional tariffs on $75 billion in U.S. exports. President Trump then announced higher tariff rates and encouraged U.S. companies in China to make other plans. The Dow sold off more than 600 points on Friday. But this week China encouraged a “calm” resolution to the issue and expressed a willingness to talk. Markets rallied higher on Monday on hopes of a resolution, a cease fire, or something.
It’s debatable just how much tangible negative effect the tariffs have on the U.S. economy. But it is some degree of not good. Probably worse is the effect of the trade war on the already teetering global economy as a global recession would harm the U.S. economy and the market.
So there you have it. A bull market that otherwise likely would have had more left in the tank is being disrupted by the trade war. As well, the volatile markets and struggling global economy probably draw the next recession closer. We have an uncertain, headline driven market with a recession looming somewhere in the future.
Of course, the trade war could be resolved next week. You never know. And the market could soar. It’s possible. The market could also meander or move slowly higher for a long time before the next recession. No one knows. But it seems like a good time to hope for the best but prepare for the worst by playing defense.
There are certain dividend-paying stocks with the potential to perform well in just about any market environment. These companies tend to make reliable profits and cash flows even when the economy turns south. I found a great one that I will highlight in this month’s issue.
[highlight_box]What To Do Now: This is one of those times in the market where investors are fearful instead of greedy. It is a market where safe stocks shine. The market has fallen every week for four straight weeks and is down 5% over the past month. And, right now, there doesn’t appear to be a catalyst out of the current woes, unless there is a trade deal.
Utilities and REITs have once again asserted themselves as the top performing sectors of the market. Portfolio REITS CCI and CHCT continue to perform well while the market languishes. BIP is also thriving as investors seek out safe plays in an uncertain economy. Then there are the utilities, NEE and XEL, that are taking the opportunity of the ugly market to make new all time highs.
Defensive stocks are the best place to be right now. But several have alarmingly high valuations, and thus are only rated HOLD. The most buyable ones right now are 5G REIT CCI and infrastructure MLP BIP. These stocks are more reasonably valued and also offer strong growth and should continue to thrive if the market turns around.
The more cyclical plays, AXP and VLO, are having a rough time of it now, but as long as the market has a good chance to turn around they are worth holding. Value plays MO and ABBV continue to languish as the market’s out-of-favor step children right now. But these are great companies at dirt cheap prices that should work over time.
EPD is another great stock to buy here but the market still isn’t really showing it any love. It isn’t going down but it’s not going higher either. Eventually, the strong fundamentals will win out and the stock pays you over 6% to wait for that day.[/highlight_box]
Featured Buy
Alexandria Real Estate Equities (ARE)
Alexandria is an urban office Real Estate Investment Trust (REIT) focused on serving the life science industry. It specializes in laboratories and research centers for biotechnology and technology in innovation clusters throughout the country. The properties are rented by primarily high quality tenants and the cash flow is well supported by long term, triple net lease contracts.
An innovation cluster is defined as a geographically proximate group of interconnected companies and associated institutions in a particular field. Places have a heavy concentration in certain areas because they naturally tend to flock together. These public and private research facilities are clustered in areas where medical and technological research spending is most concentrated including the greater Boston area, San Francisco, San Diego, NYC, Seattle and Maryland.
These areas enjoy robust funding from charities, governments and private companies and demand for facilities is high. The mix of tenants includes public biotech (27%), multinational pharmaceutical (25%), life science (17%), institutional (10%), technology (10%) and private biotech (7%).
I like this better than other REITs for several reasons. Healthcare REITs have underperformed other REITs recently because several property types, most notably senior living facilities, have gotten overbuilt. Other properties that depend on reimbursements from the government face legislative risk. But quality research labs in areas where research spending remains robust have not been overbuilt and demand remains strong. The properties are also popular with both political parties and they face little legislative risk.
Office REITs are more cyclical and contend with the issue of more people working from home. Research labs are unique and far less cyclical. And Alexandria is one of the few REITs focused on such properties.
The Formula
Triple net leases are a formula that many of the most successful REITs use and they account for 97% of Alexandria’s revenues. With these leases, the REIT buys properties and leases them back to tenants where tenants pay all taxes, insurance and maintenance expenses. The lessee doesn’t have to worry about unexpected expenses. In addition, the tenants sign long term contracts with automatic increases built in.
Most of Alexandria’s tenants are high quality, investment grade rated companies. Not only are the facilities defensive but the lease terms are as well. The average remaining lease term is 8.3 years and 12 years for the top 20 tenants. Earnings predictability is the key to paying a consistent and growing dividend and generating high returns in any economy.
The Payout
The REIT pays a modest 2.74% yield at the current price, but it is well supported and likely to grow. Alexandria has just a 60.5% payout ratio, very low for a REIT which pays no corporate income taxes provided the bulk of earnings are paid out to shareholders. The low payout enables the company to retain earnings which it can invest in additional properties to grow earnings and the dividend. It’s grown the payout at an average annual rate of 8% over the past five years and enjoys investment grade credit ratings.
This REIT has been a stellar and consistent performer in all kinds of markets. Over the past year when the S&P 500 returned just 1.24%, ARE returned 19.33%. It also returned an average of 15.76% over the last five years and 13.43% over the past three, significantly outperforming both the overall market and the REIT index.
Going forward, ARE has the best tailwinds possible, megatrends. The reliable and growing dividend along with the highly defensive nature of the business should make it a winner in the current environment.
Alexandria Real Estate Equities (ARE)
Security type: REIT
Industry: Healthcare/Office
Price: $149.75
52-week range: $109.04 - $151.24
Yield: 2.59%
Profile: Alexandria Real Estate Equities is an urban office REIT uniquely focused on collaborative life sciences and technology campuses in the nation’s most prominent innovation cluster locations.
Positives
• Properties are a unique focus in laboratories where the supply/demand dynamic is strong and they aren’t vulnerable to legislative risk.
• Cash flow is supported by long term triple net leases with automatic increases built in.
• Medical research has a powerful tailwind from the aging population.
• More Fed rate cuts should bolster REITs in general.
Risks
• New competition could come on the market.
• Charitable endowments for research could dry up in a sustained recession.
• The REIT payout structure limits the company’s ability to grow.
Portfolio at a Glance
Portfolio Updates
High Yield Tier
The investments in our High Yield tier have been chosen for their high current payouts. These ?investments will often be riskier or have less capital appreciation potential than those in our other ?two tiers, but they’re appropriate for investors who want to generate maximum income from their? portfolios right now.
BUY – Brookfield Infrastructure Partners (BIP 47 – yield 4.4%) – I’m very happy with the way this stock is behaving. It’s delivering as advertised. BIP is supposed to be a good solid defensive play in the growing infrastructure sector. In the past tumultuous month while the market is down 4.7%, BIP is up 5.9% and achieved a new all time high today. The market loves this stock right now, and the affair could last a while. It’s recently embarked upon an asset rotation strategy, whereby it sells mature assets and buys higher margin ones—and the strategy is working. Last quarter Brookfield grew funds from operations (FFO) at 15% compared to 5% in the first quarter and management indicated that similar results should persist in future quarters.
HOLD – Community Health Trust (CHCT 43 – yield 3.9%) – Let the good times roll for this small healthcare REIT. It’s a star performer in a perfect market niche for the current environment. REITs are doing great and should continue to do so as rates are likely to be cut more. And healthcare is the ultimate defensive sector that investors gravitate toward when they fear recession. In addition, the smaller size than its peers gives it more upside. Despite the fact that the stock has returned over 50% year-to-date it continues to move higher just about every week, even in a down market. It’s the Energizer REIT right now. We’ll see how long it can roll on.
BUY – Enterprise Product Partners (EPD 28 – yield 6.3%) – I don’t know what to say. The market continues to treat the energy sector like a stray dog that’s foaming at the mouth. Sure, bad news about the global economy is bad for oil prices. But EPD barely has any exposure to commodity prices. It makes money storing and transporting the stratospheric volumes of oil and gas sloshing around the country. It also has plenty of additional assets coming on line and should continue to grow earnings. But I’m optimistic because I’m old fashioned. I believe that rising earnings with a well-supported and growing 6% payout will ultimately be appreciated. To be accurate, the stock hasn’t really sold off, it just hasn’t gone anywhere. But fundamentals usually win out in the end.
HOLD – STAG Industrial (STAG 28 – yield 4.8%) – This stock hasn’t held up as well as the other REITs in this market. It’s been performing about on par with market. It’s likely because the industrial sector is more cyclical and vulnerable to the global economy and China trade headlines. It’s still outperforming the market on a year-to-date basis but it’s been lagging the other REITs. It tends to do well in up markets but if the market weakness continues I will consider taking a profit on all or part of the position.
Dividend Growth Tier
To be chosen for the Dividend Growth tier, investments must have a strong history of dividend increases and indicate both good potential for and high prioritization of continued dividend growth.
BUY – AbbVie (ABBV 66 – yield 6.4%) – Here’s the good news. In the past month, AbbVie is only down about half as much as the overall market. It’s so beaten down already it has less downside. Look, it’s a great company selling at a bargain basement price. It has a fantastic pipeline. Evaluatepharma rates the potential of new drugs. Abbvie had the number one rated recently approved drug of the year with Skyrizi and two weeks ago the number one rated drug pending approval got FDA approval, a rheumatoid arthritis treatment. Longer term, this should be a big winner but I don’t know how long it will take. In the meantime, you get a 6.4% yield on a stock that should hold up relatively well if the market turns south.
HOLD – Altria (MO 45 – yield 6.9%) – This company can’t do anything right these days. Even good news turns rancid at lightning speed. Yesterday the stock unitially rallied over 11% to $52.45 when Phillip Morris and Altria announced plans to merge. The two companies split in 2008, with PM taking the international side and Altria the US sales. They are planning to combine again. At first glance, this looked like a positive development as Altria will be able to sell its E-cigarettes into an international market with massive potential. Cigarette sales are also more stable overseas. Then, the details came out that neither stock would get a premium from the deal—and MO closed down 4% for the day. That seems like an awfully harsh turnabout. Apparently, there is concern about the valuation of E-cigarettes in a merger, with all the regulatory scrutiny, and Altria could be devalued somewhat. The deal is still a long way from done and more details will come out. For now, it’s a HOLD.
HOLD – American Express (AXP 118 - yield 1.3%) – Shares of the credit card giant tanked 4% in the market selloff last Friday. The trade war escalation spooked shareholders over Amex’s exposure to the international economy. Operationally, things have been sound but a global slowdown is its biggest vulnerability right now. I’m not panicking yet but if things take a turn for the worse in the global economy I will certainly reconsider.
BUY – Crown Castle International (CCI 147 – yield 3.1%) –Everything is beautiful with this 5G superstar. In the past month while the overall market fell 5%, CCI was up 12.2%. That’s nice down market performance. The 5G build-out will continue in haste regardless of the state of the economy. The stock should be solid if the market turns south while it will also likely participate if the market turns around. It’s another defensive stock that is performing as advertised.
BUY – Valero Energy Corp. (VLO 72 – yield 4.9%) – There are a lot of things to like about this stock, but down market performance isn’t one of them. The stock is down over 14% in the past month. It should however be a fast riser if the market turns around. I like American refiners right now and this one in particular. They still have a big advantage with cheap and abundant US crude oil feedstock. As well, there is a good chance profits rebound strongly in 2020 with the new IMO standards and other factors swinging back into favor. It’s worth being patient. Things can turn around very quickly in the refining business. But if the market looks like it will turn seriously south, I’ll reconsider.
Safe Income Tier
The Safe Income tier of our portfolio holds long-term positions in high-quality stocks and other investments that generate steady income with minimal volatility and low risk. These positions are appropriate for all investors, but are meant to be held for the long term, primarily for income—don’t buy these thinking you’ll double your money in a year.
BUY – Invesco BulletShares 2019 Corporate Bond ETF (BSCJ 21 – yield 2.3%)
BUY – Invesco BulletShares 2021 Corporate Bond ETF (BSCL 21 – yield 2.8%)
This is the kind of market where you truly appreciate these bond funds. The prices never budge. They just keep rolling on at a steady price paying interest. When the market booms these ETFs seem like a waste and dead money but when things turn ugly you’re happy you have these. Holdings like these add intangible effects as well like giving you more confidence to stay invested in the rest of the portfolio. A meteor could hit the earth and these prices wouldn’t budge.
BUY – Invesco Preferred ETF (PGX 15 – yield 5.4%) – This preferred stock ETF has held on like a rock in the market tumult so far. It is a high yielding, safe haven port in the market storm. The lack of correlation to the stock and bond markets make this a fantastic portfolio holding in just about any market. The falling interest rates make it even more attractive on a relative basis. If you’re looking for a stable price and a strong yield this is a great holding. It’s strong performance in the down market is very encouraging.
HOLD – McCormick & Co (MKC 163 – yield 1.4%) – The spice maker’s stock fell 4.35% last week after JPMorgan downgraded MKC to “underweight” from “neutral” based on valuation. There is some truth to this. The stock is selling at significantly higher valuations than the five year averages. But high historic valuations have not impeded many safe dividend stocks in this uncertain environment with falling interest rates. MKC has a habit of brushing off bad news and resuming its slow slog higher. It looks like the stock is doing it again as it has moved higher in the past week while the market has declined. The stock is still worth holding here for its down market credentials.
HOLD – NextEra Energy (NEE 223 – yield 2.2%) – It’s no accident that REITs and utilities have been the best performing sectors in the down market over the past month. Defensive businesses and dividends are the antidote to China trade headlines and recession worries. NEE is up 6% over the past month while the S&P 500 is down 5%. While investors are running for the hills, NEE is taking the opportunity to make new all time highs. Its performance in the up market was none too shabby either. The only thing better than a utility stock in a rough market is the very best utility there is. Bring it on. This stock likes good news, but it loves bad news.
HOLD – Xcel Energy (XEL 64 – yield 2.6%) – Just about everything about NEE applies to this similar but smaller utility. It has the all the defensive advantages of a regulated utility while providing more growth than its peers via its alternative energy assets. XEL has also taken the opportunity of a volatile market to make a new all time high. It’s been a stellar portfolio performer and it should continue to thrive. Even if the current selloff abates, investors will be spooked back into defensive companies like this once again. The lower interest rates are also propelling utilities higher. Times like this really exemplify what a magnificent holding this stock truly is. It delivers as advertised.
Dividend 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 Dividend Investor for an explanation of how dates estimated.
Wall Street’s Built-in Arbitrage
Investing works best as a long term proposition. But you would never know that following the market news. Everyone is obsessed with next week or next month. Occasionally, you can find a deep thinking pundit who considers the rest of the year.
To call Wall Street types short term thinkers is a vicious insult to short term thinkers everywhere. I know these people. They can’t think beyond the next quarter. They need to show good numbers now. They need to secure their jobs now. If you tell them about something great that will happen in two years, it’s like telling them it will happen in 2042. They don’t even know if they’ll still be alive then.
The vast majority of information out there is obsessed with and only cares about the here and now. The mad scramble for near term results leaves great values and opportunities behind. Those who take advantage of the arbitrage between Wall Street’s short term obsession and the longer term prognosis can make a great fortune.
Take Warren Buffett for example. Two things strike me about his thinking. One, he is a perma-bull who believes in this country. Two, he looks for great companies selling at bargain prices and doesn’t care about the near term. Recently, he put a huge amount of money into bank stocks.
Of course, the short term prognosis for bank stocks stinks. Interest rates are falling and the economy is sputtering. These things are bad for banks. It’s also a lousy economic cycle for banks, in the aftermath of the financial crisis. It really doesn’t look like bank stocks will soar any time soon. But Buffett doesn’t care.
He sees valuable franchises selling at dirt cheap prices. They are a bargain and a steal at current prices. The market always figures it out eventually. He figures that in five to ten years these stocks will likely be worth many times the price they are trading today. And he doesn’t much care how they get there.
He’s been pulling off this same trick for decades. And now he’s worth about $100 billion.
The point is that there is great value beyond the trade war and the inverted yield curve or the timeline of the next recession. Wall Street’s short-sightedness leaves great values dying on the side of the road. Try to take the long view sometimes. It will serve you well.
[premium_html_footer]
Your next issue will be published September 25, 2019
Cabot Wealth Network • 176 North Street • Salem MA 01970 • 978-745-5532
Neither Cabot Wealth Network nor our employees are compensated by the companies whose stocks we recommend. Sources of information are believed to be reliable, but are in no way guaranteed to be complete or without error. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on the information assume all risks. © Cabot Wealth Network. Copying and/or electronic transmission of this report is a violation of U.S. copyright law. For the protection of our subscribers, if copyright laws are violated, the subscription will be terminated. To subscribe or for information on our privacy policy, call 978-745-5532, visit www.cabotwealth.com or write to support@cabotwealth.com.
[/premium_html_footer]