AQNU - The More It Drops The More I Buy

2024-01-19 07:05:00 ET

Summary

• The recent sell-off in utilities, financials, and precious metals stocks is due to rising treasury yields as a result of hawkish comments from Federal Reserve officials and robust economic data.
• We explain why this sell-off is unlikely to last.
• We also share some of our top picks that we are buying on the dip.

The recent rise of the 10-year Treasury yield above 4% and the concurrent sell-off in utilities ( XLU ), banks ( KRE ), and precious metals ( GLD )( SLV )( GDX ) stem from a blend of hawkish comments from Federal Reserve officials and robust economic data that indicates that inflation may be proving more sticky than previously expected. As a result, many quality dividend stocks in these sectors are now on sale. We are taking advantage of this by purchasing more of these stocks as prices continue to drop.

In this article, we will discuss why we do not think that the current sell-off is justified and then share some of the utility/infrastructure, bank, and mining dividend stocks that we like right now.

Why The Sell-Off Likely Won't Last

After Powell's seeming dovish pivot in December sparked a Santa Claus rally, some Federal Reserve officials have recently taken a more hawkish stance on interest rates. For example, Raphael Bostic, chief of the Atlanta Fed, believes the Fed policy rate should end next year in the 4.75%-5% range, higher than the market is currently pricing in. Other Fed officials like Loretta Mester, Christopher Waller, and Thomas Barkin have also recently shown a more hawkish stance on interest rates.

Their perspective has been bolstered by recent U.S. economic data, with inflation figures slightly easing but still above the Federal Reserve's 2% target in most cases. For example, the Consumer Price Index ((CPI)) edged 3.4% higher over 12 months through December 2023, following a 3.1% increase in November. Additionally, recent economic and market data suggest that 2024 will bring slow but steady economic growth, with stronger-than-expected consumption and jobs data recently coming out.

These factors have led to a shift in market expectations, contributing to the recent rebound in Treasury yields and making dividend stocks, particularly in bond substitute sectors like utilities, less attractive as the relative appeal of their dividend payouts diminishes in comparison to the now higher yields offered by safer Treasury securities.

However, there are several reasons why we believe that interest rates will not remain higher for longer:

1. Corporate bankruptcies are on the rise , with 2023 being a worse year than 2020 for this metric. With a wall of corporate debt (and commercial real estate debt in particular) coming due in the near future, the Fed will likely be pressured into slashing rates, lest it plunge the economy into a severe recession.
2. The interest expense on the U.S. debt is becoming increasingly burdensome. With increasing military expenditure pressures mounting due to the wars in Ukraine and Israel, not to mention the arms race with China, there will likely be significant political pressure on the Federal Reserve to ease its quantitative tightening program, especially during a major election year.
3. The Fed's preferred inflation metric - PCE - is running below its target 2% rate over the past six months. While six months is not long enough to declare the war on inflation officially over, it is still a long enough time period to conclude that the Fed is certainly close to achieving its objective of crushing inflation.
4. Household balance sheets are also being increasingly strained, with credit card debt at record levels . This implies that consumer spending is likely near its peak and - barring a cut in interest rates - will likely begin to recede in the near future.
5. Several leading indicators such as the Yield Curve Model and the State Coincidence Index Model both give a high chance of recession hitting in the near future.

As a result, we expect that the market's sentiment will resume its shift towards prioritizing bonds ( BND ), precious metals, and defensive bond-like substitutes in the near future as investors become more concerned with being more defensive rather than worrying about higher for longer interest rates.

Some Of Our Favorite Dividend Stocks Right Now

Given our outlook, we think that right now is an excellent opportunity to load up on quality dividend stocks that have been beaten down in recent weeks. Here are some of our favorites that we are buying on the dip:

• Blue-Chip Miners Barrick Gold ( GOLD ) and Newmont Corporation ( NEM ) both boast strong investment grade credit ratings with very low debt levels and significant liquidity, plenty of tier-one assets, pay attractive dividends relative to their industry and trade at significant discounts on a P/NAV basis relative to peers. With significant multi-decade gold and copper production profiles for both of them, we think that now is an opportune time to load up on their shares.
• Algonquin Power & Utilities ( AQN ) has a solid BBB credit rating and owns high-quality utilities and renewable power assets. Moreover, AQN is attractively priced with a dividend yield of over 7%. AQN's management expects to unlock considerable value for shareholders by selling its renewable power generation and development business this year at a value-accretive price and recycling the proceeds into debt reduction and meaningful share repurchases. We are confident in their ability to do this because JPMorgan ( JPM ) performed a comprehensive analysis of the company and not only recommended that they sell their renewables business, but also provided them with a range of value that they should expect to get for it. Management has mentioned that they are already fielding "interesting" offers from potential buyers, implying that there is pretty strong demand for and interest in their renewables business. Moreover, activist investing group Starboard Value has been working alongside the board this whole time and also lobbied hard for the sale of the renewables business as a means to unlock considerable value for shareholders. Since management announced its planned sale of the renewables business, Starboard has increased its position in AQN by a whopping 71%. This implies that an external investor - who has had close contact with the board and likely has at least some enhanced visibility into the strategic review and sales process - has confidence in management's ability to unlock value.

• Financial stock New York Community Bancorp ( NYCB ) combines an attractive current yield of ~7% with strong growth potential (analysts project a 6.9% CAGR in earnings per share through 2025). Furthermore, NYCB is undervalued compared to historical metrics, with a P/BV of under 0.7x and a P/Tangible BV of under 1x, both well below its five-year averages. With 60% of its deposits FDIC insured and a focus on low-risk, rent-regulated multifamily loans, minimizing exposure to office loans, NYCB is relatively conservatively positioned.

Investor Takeaway

While many defensively positioned dividend stocks have taken a beating lately, we think that they have seldom been more attractive from a risk-reward standpoint than they are today:

• Numerous factors indicate that the Fed will likely be forced to cut sooner rather than later.
• A recession is still highly likely to hit, putting a premium on defensive businesses.
• Their valuations look very attractive after the latest sell-off, especially relative to the S&P 500 ( SPY ), which looks overvalued based on numerous metrics.

As a result, we are loading up on undervalued precious metals, utilities, and financial dividend stocks similar to the ones mentioned in this article.

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