This is a guest contribution on Sure Dividend by Tom Hutchinson, Chief Analyst, Cabot Dividend Investor
The broader S&P 500 index officially fell in a bear market in June, down more than 20% from the high on a closing basis. The index has since rallied somewhat off the lows. But the problems that drove stocks into the abyss in June are not anywhere close to being resolved.
The main culprit is inflation and the Fed’s reaction to it. Inflation continues to rise to levels not seen in 40 years. Meanwhile, the behind-the-curve Fed, which should have acted a year before they did, is being uncharacteristically aggressive in raising rates. The Central Bank has raised the federal funds rate by higher amounts than they have in decades over the last two meetings and have vowed to continue meaningful rate hikes in future meetings.
There is increasing skepticism that this inflation can be tamed without the Fed driving the economy into a recession. Of course, predictions have a way of not panning out. It is possible that we avoid a recession. Inflation could recede all by itself and the Fed won’t have to be as aggressive as currently feared. Commodity prices have already fallen significantly over the last month amidst all this inflation talk. Oil prices, which have played a huge role in driving inflation higher, are down a lot.
But all the Fed’s recent bluster hasn’t done a thing to tangibly quell inflation so far. The June CPI number came in at a whopping 9.1%, higher than expected, and the highest reading yet this cycle. Inflation appears to be laughing at the Fed’s actions to date.
Of course, the lower gas prices should drive the inflation number lower for July and create a sense among investors that inflation has peaked and is moving down. But commodity prices are notoriously volatile and can spike higher again at any time. The current fall in gas prices isn’t enough to hang your hat on.
Plus, core CPI, which measures prices excluding food and energy, is still over 6%. That’s still way high. It’s also worth noting that if CPI was calculated the same way it was 40 years ago, the number would be much higher, and worse than most of the 1970s inflation.
There is a strong chance that the Fed will have to be aggressive enough that it drives the economy into a recession to fix this inflation. But there are a lot of negatives associated with that. The Fed may stop short and allow inflation to persist. We’ll see.
It looks like a fight that will leave one man standing at the end, inflation or recession. That’s a problem for investors because different stocks thrive and fall in each situation. Energy and other cyclical stocks that thrive in inflation are not good in a recession. Other defensive plays that work in a recession don’t like inflation.
It’s a conundrum where the best bets right now are with those rare stocks that can endure both situations. Here are two good ones.
Xcel Energy (XEL)
Utility stocks are well suited for recession. The sector is the most defensive on the market as earnings are virtually immune to economic cycles. Stocks also pay high dividends and typically hold up very well in down markets.
Xcel is a small and not particularly well known alternative energy utility. But the smaller size may also provide more potential upside.
Xcel is a regulated electric and natural gas utility serving 3.7 million electric customers and 2.1 million natural gas customers in eight states, primarily in the northern and southwestern U.S. It is also one of the largest renewable energy providers in the U.S. with 28% of electricity sales generated from alternative energy sources.
The utility has been heavily investing in clean energy, primarily wind and solar power. Xcel now generates about a third of the electricity it delivers from these clean sources. The company has an ambitious goal of reducing carbon emissions 80% by 2030, from 2005 levels, and being 100% carbon free by 2050. It’s on track as carbon emissions are already down more than 44% from 2005 levels.
XEL stock has consistently blown away the returns of the utility sector; it’s also beaten the return of the S&P 500 over the past one-year and 10-year periods. Investors have gotten returns that have bested the overall market with far less volatility. The stock sports a beta of just 0.36, meaning it is barely more than a third as volatile as the overall market.
Sprinkle in a 2.9% dividend yield, and that’s a reliable utility stock to own, in any market or economic environment.
Investors rediscover the defensive attributes of healthcare stocks in times like this. That’s why healthcare in the best-performing sector over the past month and the second-best performing sector over the last three months. Healthcare will continue to thrive regardless of the state of the economy.
AbbVie is a cutting-edge company specializing in small molecule drugs. It has grown into the eighth-largest pharmaceutical company in the world, primarily on the strength of its blockbuster biologic autoimmune drug Humira, which is the world’s number one drug by far with annual sales of about $19 billion.
The stock floundered for a while on fears of Humira losing its American patent in 2023. But investors have since realized that the strength in AbbVie’s pipeline and growing newer drugs on the market can overcome the loss in revenue.
AbbVie has what EvaluatePharma recently called the second best pipeline in all of pharma, with many more drug launches in the next few years. And Humira isn’t likely to disappear. It’s still estimated to be one of the world’s top-selling drugs until at least the middle of this decade.
To further diversify away from dependence on Humira, AbbVie purchased Ireland-based Allergan for $63 billion. The company is about half the size of AbbVie and features blockbuster facial treatment drug Botox. The acquisition diversifies the company away from Humira in the near term while the stellar pipeline gains traction.
This is one of the best and most advanced drug companies in the world with the enormous tailwind of the rapidly aging population. The longer-term prognosis is fantastic as the company is effectively addressing the near-term issues.
Despite the fact that ABBV has returned more than 9% YTD in a tough market and 26% over the last year, the stock still sells at a dirt cheap valuation of just 11 times forward earnings.
This article was first published by Bob Ciura for Sure Dividend
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