3 Stocks I’m Buying As We Close In On Fed Rate Cuts

krblokhin/iStock via Getty Images Greetings from the Rocky Mountains! I make my pilgrimage to this slice of alpine paradise every summer, partly to escape the hellish heat of Texas but mostly for the profound pleasure of traversing Colorado’s hiking trails. Around New Year’s Eve, I wrote an article titled “Investing In The Good Life” in which I explored 10 elements of the optimally happy and fulfilled life, according to both science and timeless wisdom. One of those elements is “time in nature.” There’s something deeply rejuvenating and restorative about hiking through mountain forests, crossing rocky streams of snowmelt, and ascending to alpine lakes, all the while letting the mind wander where it will as the brain focuses simply on the function of plotting one’s next steps. The verdancy and fecundity of a mountain ecosystem in the summertime incites creativity and imagination like nothing else, in my experience. Forgive my rhapsodic indulgence. I am but “a poet trapped inside the body of a finance guy,” to quote Taylor Swift. Let’s get to the real reason you’re here. Here’s the merchandise on offer today: The economic cycle remains undefeated, and the trends are not pointing toward a reacceleration or soft landing. The great rotation from mega-cap tech to REITs and other dividend stocks may have just begun. My slimmed down buy list of just three dividend stocks. Let’s get to it. The Economic Cycle Is Undefeated I’ve said many times in the past that the nature of the economy is not equilibrium or stasis but rather cyclical undulation. It isn’t as though there is some steady state to which the economy returns once it has absorbed occasional shocks. The economic cycle is the steady state. The technocratic mindset pervasive among Fed economists and governors seems to be that we can engineer away this economic cycle — that by tweaking the levers and dials in just the right way, we can avoid recessions indefinitely. Perhaps an omniscient being with perfect foreknowledge could accomplish that, but my understanding is that no such being is employed at the Federal Reserve. As such, we should not be surprised to find that after the economic surge of 2021-2023, we now find ourselves in the downward part of the cyclical wave pattern. All but the most affluent consumers are reining in their spending, having depleted their savings and run up credit card debt. Unemployment has definitively bottomed and begun its inexorable, if slow, upswing again. Inflation, once red hot during the unprecedented levels of consumption courtesy of Uncle Sam’s money printing, continues to form a camel hump pattern instead of the dreaded “higher for longer” stagflation that many feared. Truflation shows inflation plunging below 2% YoY, AIER’s Everyday Price Index likewise showed a rare drop in June, and CPI ex shelter came in at 1.8% YoY in June. The disinflationary forces of aging demographics, excessive debt, income/wealth disparity, and technological advancement are reasserting themselves. I know how little anecdotal evidence is worth, but having come to Colorado every summer for the past 8 years, I notice that the state’s touristy mountain towns are significantly less trafficked this year than the 2020-2023 summers. Don’t get me wrong. By all appearances, the ultra-affluent are still doing great. But the lower-tiers of the affluent — the same folks who have recently traded down to grocery shop at Walmart (WMT) instead of higher-end stores — are not as flush with cash in 2024 as they have been over the previous three years. Here’s a non-anecdotal piece of evidence: Backyard pool installations have plunged by some 50% since peaking in 2021. Chartr Yes, it’s true that many pool installations were simply pulled forward from future years to the 2020-2022 period. It doesn’t necessarily indicate people can no longer afford to put in a pool. Even so, by nature of heightened economic activity in 2020-2022, we were almost destined to see a pullback in activity in the following years. However, there’s some reason to think the drop in discretionary spending on things like pools is indicative of consumer weakening, because the personal savings rate remains near its lowest level since the early 2000s. Data by YCharts Most households are spending all or almost all of what they make. And many households are spending more than what they make, as evinced by soaring levels of credit card debt (and rising delinquency rates). I can hear the objection: But what about air travel? TSA throughput is breaching all-time highs! Consumers are spending money on travel more than ever before! Torsten Slok It’s true. I can’t deny that travel & leisure spending continues to generate economic activity and growth, at least in some areas of the economy. But that point has to be caveated with the fact that summer travel plans are largely being funded with credit card debt. According to WalletHub (via the American Bankers Association), US credit card debt soared to a new high of $1.27 trillion in May, up 14% from the end of March and 12.5% from the previous record high at the end of 2023. And that does not even count June! Over the past three years, credit card debt has increased 3x faster than disposable personal income. That pattern is only accelerating. The WalletHub research shows that almost half (46%) of credit cardholders are still paying down debt from last summer, along with mounting interest as the average credit card APR sits at almost 23%. Travel plans are made well ahead of time. Record levels of air travel this summer feels more to me like the last hurrah of the post-COVID boom than the start of a new phase of economic growth. Here’s another sign of the times: Bankruptcies are on the rise and breaching COVID-era levels. S&P Global Market Intelligence It’s meaningful that consumer discretionary companies are the largest category of bankruptcies. Whereas healthcare and industrial bankruptcies might be attributable to private equity sponsors having overloaded them with excessive debt in years past, the spike in consumer discretionary bankruptcies seems to communicate something about the state of American consumers. Likewise, as bankruptcies rise, so too is the unemployment rate rising. The June jobs report showed a 4.1% unemployment rate, triggering the historically accurate “Sahm Rule,” stating that a 3-month average unemployment rate 50 basis points above its lowest point over the last year coincides with the beginning of recession. Joe Consorti The economic cycle stands undefeated. It hasn’t been engineered out of existence. The next phase of this cycle, if the historical pattern does indeed hold, is recession and falling interest rates. Already, around 40% of global central banks have returned to easing mode. That number is expected to reach 80% by the end of this year. Ned Davis Research Of course, it’s always possible that this time is different. But it’s usually a bad idea to bet on “this time is different.” Leadership Change? I’ve commented on the stock market’s narrow breadth in recent weeks. Here’s a chart illustrating this market narrowness: Torsten Slok In a wide-breadth bull market driven by a broadly strong economy, you’d expect exactly 50% of stocks to be outperforming at the time. Today, the market has recently been driven to new highs primarily by a relatively small number of stocks like Nvidia (NVDA), Amazon (AMZN), Microsoft (MSFT), and Apple (AAPL): Data by YCharts These mega-cap giants, each the size of many developed nations’ entire economies, have been pulling all cap-weighted stock indices up with them. Today (Thursday, July 11th), as the market can now see the whites in the eyes of Fed rate cuts, that leadership may be changing. The SPY is down almost 1% today, while the Nasdaq index (QQQ) is down almost 2%. But my REIT-heavy dividend stock portfolio is up 2.5%. Now, my portfolio has underperformed for a long time, so I’ll refrain from dunking on anybody yet (after one trading day!). But I will say that I’ve been making the argument to buy REITs and other income-oriented stocks for a while. More specifically, the argument I’ve been making is that disinflation and economic weakening will lead to rate cuts (and lower interest rates across the curve), which will then translate into a strong rally in dividend stocks, especially REITs. REITs in particular are treated like fixed income alternatives, and fixed income funds have suffered an outflow of AUM while money markets have enjoyed a huge surge. Bloomberg Finance It makes sense prima facie. Why invest in long-term bonds at a lower yield than virtually riskless money markets at a 5%+ yield? But as you can see above, in recent decades, money market AUM has only eclipsed fixed-income AUM after the Fed Funds Rate peaks. Then, after the Fed cuts, money market AUM flows back into fixed-income. By extension, some of these funds in money markets also flow into REITs and other dividend stocks. But that outflow from money markets hasn’t really started yet. It usually doesn’t start until some months after Fed rate cuts. For now, it appears that money is flowing out of those mega-cap tech stocks and into the real estate (VNQ) and utilities (XLU) sectors. Data by YCharts NVDA dropped 5.5% on Thursday. MSFT dropped 2.5%. AAPL and AMZN both dropped 2.3%. Could this be the start of a trend? Or just a temporary blip that traders will shake off in the coming days and weeks? Your guess is as good as mine. But consider this: As of May (this chart is slightly dated but remains generally true), REITs traded at a GFC-level discount to the broader stock market: Cohen & Steers Recently, Jussi Askola and I published an article titled “A Once-In-A-Decade Buying Opportunity In REITs.” We weren’t kidding. Yes, we know that we’ve used that phrase before over the last few years while REITs have continued to lose ground against the inexorable advance of mega-cap tech. We fully admit to being human when it comes to timing the bottom. But given the extreme level of investor pessimism around REITs, the critical comments we receive every time we pitch them, the degree of underperformance against other stocks, and the valuations/yields many REITs have reached, we firmly believed this sector is rife with fantastic buying opportunities. Today illustrates why we disagree with commenters who argue for leaving their money in 5%-yielding money market funds until the Fed cuts rates and only then transferring it over into REITs. After one trading day, the buying opportunities in REITs are less good, the valuations higher, the yields lower. By the end of this year, unless there is some sort of market crash, I believe the buying opportunities in REITdom will be less good still. And even if the broader stock market indices do decline going forward, REITs and certain other defensive dividend stocks need not decline with them. Simply consider the sectoral weights within the SPY. While tech is over 33%, real estate is a mere ~2%! Investopedia Anytime an S&P 500 ETF or fund receives selling pressure, it is the mega-cap tech names with the largest weightings that necessarily see the biggest price drops. On the other hand, the REITs in the S&P 500’s tiny allocation to real estate should see much more minimal downward pressure. If investors sell shares of SPY to reinvest into REITs, they are largely selling tech to do so. Moreover, many, including yours truly, have drawn comparisons between today’s market and that of the late 1990s, when tech stocks were surging on optimism about the Internet. When that bubble burst and tech stocks came back to earth in the following years, guess what REITs did… Data by YCharts From the beginning of 2000 through the end of 2005, the cheap and beleaguered REIT sector trounced the market, nearly tripling while the cap-weighted indices slowly recovered from the excesses of Dot Com bubble euphoria. Now, I’m not saying that today’s AI-fueled tech stock rally is identical to that of the late 90s. Nor am I saying these stocks are in a bubble. Nor am I arguing that REITs will outperform tech stocks to the same degree over the next 6 years as they did from 2000 through 2005. What I am saying is that REITs are poised to perform very well going forward, perhaps even outperforming tech stocks over the next few years. I, for one, am betting on that. The Post-Ozempic Buy List My buy list has apparently been taking Ozempic, because it’s a lot skinnier than it was in the recent past. Last week, before the June CPI print gave Powell & company a little more of that confidence they’re looking for to cut the Fed Funds Rate, my buy list was much longer — with some other undervalued dividend stocks that arguably could have been included. Here’s how some of the names on last week’s buy list performed on Thursday, July 11th: American Tower (AMT) – Up 5.3% Hannon Armstrong Sustainable Infrastructure (HASI) – Up 10.5% Essential Utilities (WTRG) – Up 5.8% Why didn’t I buy more??? Also, on June 15th, my weekly article was titled “9 Stocks On My Buy List As Fed Rate Cuts Approach.” Here’s how those 9 stocks have performed against the S&P 500 (SPY) since June 15th: Data by YCharts The average return on a price basis alone is 4.84%, compared to the SPY’s 2.7%. This doesn’t include dividends, which cause these 9 stocks’ collective outperformance to rise even further due to their higher dividend yields than SPY. The two underperformers have been SRE, which is inexplicable to me, and CMCSA, which I believe is explicable mainly by the apparently accelerating cord-cutting phenomenon. Southern Californian industrial landlord REXR remains a great buy, in my judgement, even after shooting up by ~9% since June 15th, but I’m not chasing the other names. Even SRE, which I’ve built into a small but noticeable position in my portfolio in recent weeks, is now trading a bit above my preferred buying level. I don’t have a “buy under” or “target” price for SRE or any other stock, as I see this binary way of thinking as being contrary to the spectrumatic (not a real word but I’m going with it) way the world works. It’s a continuum, not an exact science. It’s ludicrous to me to say a stock is a “buy” at $49.99 but a “hold” at $50.01. That said, SRE at $77 a share has risen ever so slightly away from the point at which it struck me, deep in my gut, as a good buying opportunity. It’s now a bit more of an “okay” buying opportunity, but “okay” isn’t enough to make it onto my buy list. That said, here are the three stocks I’m still buying: Dividend Yield Projected Forward Dividend Growth Rate (Guesstimate) Brookfield Infrastructure Partners (BIP) 5.3% Mid-Single-Digit Clearway Energy Inc. (CWEN.A) 7.0% Mid-Single-Digit Rexford Industrial (REXR) 3.4% High-Single-Digit to Low-Double-Digit Click to enlarge Since I’ve already pitched REXR many times, I’ll focus on the other two. Brookfield Infrastructure BIP is a hard one to pin down. The publicly traded partnership, which also has a corporate equivalent (BIPC) with no K-1, owns a wide variety of infrastructure assets, from midstream energy to toll roads to data centers. BIP May Investor Fact Sheet Within BIP’s portfolio are some cyclical and some defensive assets, but overall I would expect it to trade somewhat like a midstream energy company. Over the last few years, though, BIP has performed significantly worse than midstream energy companies such as those found in the Global X MLP & Energy Infrastructure ETF (MLPX) and the Alerian MLP ETF (AMLP): Data by YCharts Why? It appears that BIP’s larger debt load causes it to trade more like a bond proxy than an energy company. Whereas midstream energy companies typically have debt to EBITDA ratios ranging from 3x to 5x, BIP’s debt to EBITDA ended Q1 at 6.9x. That is admittedly higher than I usually like to see, but most of BIP’s debt is in the form of amortizing, asset-level loans. As such, its debt level should decline naturally over time as principal payments are made. The combination of a 5.3% yield with mid- to high-single-digit dividend growth (BIP’s historical average annual dividend growth has been 9%) is extremely compelling. While I really like BIP’s strong midstream natural gas assets, its fast-growing data segment (data centers and cell towers), and its defensive utility operations, I do worry a bit that its ports and 7 million shipping containers would suffer if the trade war makes a resurgence. That worry isn’t enough to keep me from buying it. Over the next few years, I would expect the benefits of lower interest rates to outweigh any negatives from rising trade barriers. Clearway Energy Inc. Clearway Energy (CWEN, CWEN.A) has a very similar financing model as that of BIP. The majority of CWEN’s debt is in the form of amortizing, asset-secured loans that get gradually paid off from the operating income of the respective projects over time. By the end of each asset’s power purchase agreement, the asset-level loan will have been fully paid off. CWEN’s corporate-level debt doesn’t begin to mature until 2028, at the earliest. I very much like CWEN’s asset mix of about 75% renewables (wind, solar, battery storage) and 25% gas-fired power plants in California. These complement each other. As CWEN continues to contract the power capacity at its gas-fired plants into the second half of this decade, the company expects to continue extending its cash flow and dividend growth at a mid-single-digit pace. And if CWEN’s cost of capital comes down to a sufficient degree, it will be able to continue investing in drop-down renewable energy assets from its sponsor, which is a renewable energy developer. If the company does manage to grow as much as it expects to, CWEN.A (the A shares which have lower trading volume but a higher yield) will generate 7-8% annual dividend growth for another 3 years before delivering another ~5% annual growth in the following 3 years. That is on top of an already 7%-yielding dividend! If CWEN’s management is able to pull it off, then CWEN.A will prove to be among the best dividend opportunities in the market today. I think the company can pull it off, which is why CWEN.A is one of my largest holdings today.

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