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The American Consumer Is Getting Weak; Here's How My Income Stays Strong

Good Morning, Income Investors!


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A problem with government numbers is that they are inherently trailing. They tell us what happened in the past. For example, the PCE inflation report measures inflation for April 2024. While the numbers were assigned to April 2024, they are not necessarily realized prices in April 2024. There is not yet a master database run by the government where every item sold in the United States is tallied and provides instant feedback about what prices are right now and what consumers are or aren't buying.

However, in the digital world, databases have startlingly detailed information on consumer buying patterns and prices. Corporations like Walmart (WMT) and Target (TGT) collect this information and analyze it intensely to make their projections.

In their earnings call, Walmart described their consumer:

"Many consumer pocketbooks are still stretched, and we see the effect of that in our business mix as they're spending more of their paychecks on non-discretionary categories and less on general merchandise"

Target's management provided similar commentary:

"Among the drivers of our comparable sales, traffic was down 1.9% in the first quarter. The average transaction was also down 1.9% as consumers continue to spend cautiously, particularly in discretionary categories."

Both companies have responded by focusing efforts on cutting costs of some of the most popular daily items for consumers. They are willing to take smaller or even negative margins on certain products, hoping to lure consumers to their stores to buy higher-margin products.

When we look at "real" retail sales, which are adjusted for inflation, they have been negative to flat for nearly two years:

Yet despite buying less, we are seeing reports of consumers increasingly turning to credit cards. Something has to give.

Perhaps the most surprising thing about every recession is that everyone is always surprised when it happens. It isn't rocket science—consumers slow down in buying things, and this causes other consumers to lose their jobs. The consumers who lost their jobs stop buying a lot of things, and more consumers lose their jobs—and voilà, a recession is happening.

We saw this from 1999 through 2001.

We also saw it from 2006 through 2008.

And we are seeing it again now.

Consumers are buying less, and unemployment is rising. The two are not disconnected facts. We know that the cost of living has gone up, and we know that wages have failed to keep pace.

Many individuals paid off debt during the global pandemic and have as such, benefited from having relatively low debt. Yet credit cards still have limits and a consumer fueled by debt has never been sustainable. This time isn't going to be different.

At High Dividend Opportunities, we aren’t accumulating cash in fear of a recession. Instead, we are focusing on buying investments that will continue to generate through one. Our top picks include sectors that experience inelastic demand across economic cycles. Let us review them now.


Pick 1: UTG - Yield 8.3%

Utilities in North America often operate in regulated markets where they maintain a monopoly over the provision of essential services like water, electricity, and gas. Moreover, this is a unique industry that can, through regulatory backing, charge more for the same product without losing customers


Reaves Utility Income Fund (UTG) is a CEF (Closed-End fund) with ~33% of its assets invested in leading North American utility companies, many of which are actively pursuing rate hike requests with the relevant regulatory authorities. This bodes well for their ability to maintain profitability and returns to shareholders through economic pressures. Source


UTG is actively managed, with a high proportion of its distributions sourced from long-term capital gains. The fund managers are experts in the industry, and we have confidence in their ability to continue extracting value from this defensive sector. The CEF pays $0.19/share, an 8.3% annualized yield.


Pick 2: VZ - Yield 6.8%

Verizon Communications (VZ) is the largest American telecommunications company by FY 2023 revenues. Verizon provides services essential for individuals and corporations in the digital era, almost making it a utility-like investment. As such, due to its stable dividends, high cash flows, and steady operations, the stock is trading as a bond proxy in this market.


VZ trades at a forward PE of 8.4x, presenting a valuable income opportunity for patient investors. The telecom leader boasts 17 years of consecutive dividend raises and remains well-positioned to deliver another raise this September.


VZ has reiterated its FY 2024 guidance, projecting 1-3% YoY adj EBITDA growth and FCF between $17-17.5 billion. Expected FY 2024 EPS between $4.50 - 4.70 per share places the annual dividend at a 57 - 59% range (assuming a 3% raise in September), indicating adequate coverage and room for distribution raises.


Conclusion

We will continue to focus on our income, finding opportunities to invest in holdings that pay us cash regularly. The market is partying while the economic news is quiet. However, as we go into June, the cycle will restart, and the market will go back to betting on what the Fed will or won't do based on the economic data. We can expect a lot more noise in the market.

Employment has been getting soft, and the risk of a blowout month confirming a recession is high. To avoid a recession, unemployment needs to come down. U.S. consumers are having trouble affording the cost of living, and becoming unemployed makes it even harder. As such, we continue to defensive investments that provide non-discretionary outputs to customers. When the market gets noisy, remember to stay calm and focus on your goals. By focusing on building our income, we can make decisions that aren't influenced by the emotions of the moment. Whatever news the economy brings, we will keep our income climbing. This is the beauty of our Income Method.


 

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