Predictions are hard, especially about the future. Yet we have to be mindful that recession risk is high, and the Fed is now telling us that it is high with its 50bps rate cut. History tells us that when the Fed has those fears, it is usually proven right in short order.
At High Dividend Opportunities, we’ve been talking in our Market Outlooks about how economies have momentum, and discussing the downward momentum the U.S. economy has had for the past two years. The Fed appears to have finally woken up to these trends and is finally acting to reverse them. Since interest rate changes take 12-18 months to filter through the economy, it is likely that they are a day late and a dollar short. Even with a double cut, it is unlikely that is enough to reverse the current trends.
My working assumptions are:
The Fed will cut much more aggressively than anyone expects. In 2001, the Fed went from 6.5% to 1.75% within a year. In 2007, it went from 5.25% to 0% in 15 months. The Fed and the Market believe this time is different. I don't.
The economic measures will continue to deteriorate. Inflation will keep drifting down, unemployment will keep going up, job numbers will keep being revised lower, and GDP will decline. This isn't necessarily going to happen every single month, but the overall trend isn't going to change anytime soon. The economy is large, it isn't going to change direction overnight.
The highest-valued stocks are the highest risk. Going into the Dot-Com bust, you wanted to own Value stocks and not Growth stocks. Going into the GFC, you wanted to own Growth stocks and not Value stocks. Recessions are frequently the pivot point for the market to exit the investments that it was the most bullish on, and move into the investments that are trading at the lowest values. Investments that underperformed before a recession are usually the ones that outperform the most during and following a recession.
At HDO, we've been discussing recession risks for two years. We've emphasized fixed income and made our portfolios more defensive. Here are a few of our top diversified investments in fixed income.
Pick 1: RNP – Yield 7%
Cohen & Steers REIT & Preferred Income Fund (RNP) is a CEF (Closed-End Fund) that invests in a combination of equity REITs and preferred shares with a roughly 50/50 mix. RNP is highly diversified by sector. On the common equity side, RNP invests primarily in blue-chip REITs considered leaders in their respective sectors. This represents 51% of the CEF’s invested assets. The other half of RNP's portfolio is preferred equity; RNP focuses on non-REIT preferred. Banking, insurance, and utility preferreds make up over 80% of the preferred portfolio.
RNP has already been rallying on the belief that the Fed would cut rates. There is a lot of room to run to the upside as September's rate cut is likely just the start of a series of several cuts.
Pick 2: JPC – Yield 9.8%
Nuveen Preferred & Income Opportunities Fund (JPC) has been gaining traction. YTD, its price is up over 20%, and with distributions, it has provided a total return of over 30%.
In June, JPC hiked its dividend by 40% to $0.0665/month, paying a yield of ~10%, mostly QDI in recent years.
JPC is a fund that focuses on preferred equity, and it complements our portfolio well because it focuses on banks, capital markets, and insurance companies. Over 80% of JPC's holdings are investment-grade, and about 90% of them are institutional preferred with a par value of $1,000. We expect strong tailwinds for this asset class with interest rate cuts, and these will benefit us directly through JPC’s increasing NAV.
The outlook is still sunny, and JPC has ample room for more upside, and is producing a hearty ~10% yield.
Conclusion
As interest rates decline, we wouldn't be surprised to see investors willing to start paying a premium for fixed-income-focused investments like JPC and RNP, as they have before. When they do, those of us who buy at discounted prices have the option to keep collecting the income, or to sell, depending on our needs and goals.
I've been hammering the table on fixed income over the past year, and I believe that is still one of the best opportunities in the market if you are buying today. This asset class increases our portfolio defense while placing generous distributions into our pockets. This is the beauty of our Income Method.
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