Consensus is emerging in the market that the U.S. Federal Reserve’s next move will be a cut in interest rates. The bond markets, for example, are pricing in the assumption that the Fed will make at least two quarter-percentage point cuts this year due to the increasing risk of recession.
That pessimism, in our view, isn’t without reason. The U.S.-China trade war has started to hurt investor sentiment and, more importantly, is now forcing companies to cut their revenue forecasts.
With corporate America beginning to feel the pain, a growing number of economic indicators are also flashing red. The New York Fed’s Empire State Manufacturing Index, released on Monday, showed the biggest monthly decline since the last recession.
If these market readings are correct and the Fed is ready to cut interest rates, then it makes sense for equity investors to seek shelter and add some safety to their portfolios. Stocks that generally outperform in a slowing economy are those that pay regular dividends. To help you get started, we have picked the following two income-producing stocks to help ride through the market volatility:
It’s not unusual for utility stocks to outperform the market in times of distress. Their business model based on recurring cash flows and their ability to pay regular dividends are some of the traits that attract investors. That’s the main reason the utility sector has continued to be one of the best performers this year with the S&P 500 Utilities gaining more than 13%.
In this space, we particularly like Nextera Energy Inc (NYSE:NEE), the Florida-based utility that has scaled up by providing clean energy. NextEra is the largest U.S. provider of renewable power, generating electricity from the wind and sun. It operates a large natural gas pipeline business as well as a growing energy storage operation.
The big difference between NextEra and other traditional utility companies is that its growth wasn’t funded by a massive injection of debt. Instead, the company very smartly used government subsidies and tax breaks offered to clean power producers. It mostly sells the output to old-school utilities, many of which must procure power from green sources to meet state mandates.
NextEra plans to invest $40 billion on its development projects through the end of next year. This should help fuel growth, especially at a time when the renewable market opportunity is huge and the company has already built an impressive scale. Shares closed yesterday down 0.5% at $205.38, but have advanced 19% this year versus the S&P 500's gains of 17%.
With a dividend yield of 2.45%, NextEra pays an annual dividend of $5 a share. The company plans to grow that between 12%-14% through the end of 2020.
Just like utility stocks, real estate income trusts, or REITs, are also a bet on the direction of interest rates. Their yield becomes attractive once the rates on safe haven government bonds fall.
Welltower Inc (NYSE:WELL), one of the largest healthcare-focused REITs, is an attractive option to consider if you’re looking to earn a higher yield. The company manages more than 1,500 properties and is focused on healthcare — a relatively safe bet within REITs due to the ageing population in the U.S. and increased spending on such facilities.
Its portfolio has a good mix of facilities to take advantage of this shift, including senior housing, outpatient medical facilities, and long-term care. These revenue-generating streams are solid, especially when the U.S. is going through a huge demographic shift where, according to some estimates, 10,000 baby boomers turn 65 each day.
Welltower is already benefiting from this trend. Its net income jumped 61% last year and is expected to grow a further 29% to around $1 billion in 2019, assuming the company meets the low-end of its profit guidance. The shares fell 0.7% to $83.04 yesterday, which only slightly dented it's almost 20% gain so far this year.
Over the past decade, this REIT has boosted its payout to $3.48 a share annually, which translates to a yield of more than 4% at the current stock price.
After a powerful rally in income-producing stocks fueled by low interest-rate expectations, these two names may not have much more room to the upside. Both NextEra and Welltower are trading close to their 52-week highs and their valuations seem a bit stretched at the moment.
But if the bond market is correct and we’re soon going to see a rate cut, we shouldn’t rule out another leg higher in the values of these stocks.
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