by Bryan Perry
September 26, 2023
As far as the Fed is concerned, interest rates will be higher for considerably longer than both the stock and bond markets were banking on. The Fed’s policy statement accompanying the rate decision laid out a path where the Fed is not expecting to reduce rates in 2024, essentially modifying (in a negative manner) their June policy statement. The new narrative triggered broad selling in both the bond and stock markets.
This new policy directive implies that the Fed favors one more rate hike by year-end while lowering the expectation for multiple rate cuts in 2024. The negative reaction by the equity market falls under the notion of further P/E multiple compression, primarily for growth stocks, helping to explain the sudden and sharp pullback in the ‘Magnificent Seven’ AI stocks that ruled the market for the front half of 2023.
The FOMC’s 2024 median rate outlook is now a lofty 5.1%, up from its outlook for 4.6% in June, while its outlook for 2025 rose to 3.9% from 3.4%. This comes as the committee noted that inflation remains elevated. This adjustment was material in the eyes of market participants and extended the market’s losing streak to three straight weeks, this past week’s losses led by consumer discretion and real estate.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Whether they’re right, wrong (or just confused), the Fed is convinced that inflation, in its various forms, will persist. It should be noted that Fed Chair Powell acknowledged that the economy has been more resilient than forecast. If the economy comes in stronger than expected, he said, that just means the Fed will have more to do in terms of monetary policy to get back to 2%, “because we will get back to 2%.”
The shift in the interest rate narrative took the benchmark 10-year Treasury yield up to 4.5% before it settled at 4.43% last Friday, but a real test of long-term overhead technical resistance is being challenged. The 2-year Treasury Note closed Friday at 5.12%, putting the closely-watched 2/10 spread at –69 basis points, a 10-bps improvement since the first of the month. The narrowing of the 2/10 spread implies a lower risk of recession, which is fine, but the market is not so focused on this spread as it is on the troubling increase in short-term rates to over 5% for maturities ranging from 1-month-to-2-years.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Against this backdrop, income investors seeking inflation-resistant income with inflation-beating yields must start to look beyond conventional high-yield debt. I see two primary sectors that are working best for both high yield and capital appreciation: (1) Energy shipping and (2) business development lending.
In the first category, spot pricing for transferring oil and natural gas around the globe is higher, with shippers locking in longer-term charter rates that raise confidence about insulating phenomenal levels of free cash flow (FCF) and the ability to pay out luscious dividend yields for extended periods.
In business lending, several business development company (BDC) stocks are trading higher as a function of holding portfolios of floating rate loans, tied to LIBOR or SOFR rates, leading to rising revenue every time the Fed increases its overnight lending rate. As regulated investment companies (RICs), BDCs have to pay out 90% of their net income, just like REITs, but with a few exceptions. They can use leverage and derivatives to enhance yield. As a result, there are a few very well-managed BDCs with bullish charts that pay out 10%+ yields. Van Eck’s BDC ETF pays 10.6% with some top-performing BDCs in the sector.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
During September, when it seemed that not much of anything was working in some of the most favored sectors, there are a handful of bright spots that aren’t just holding their own in terms price performance, but also delivering the kind of payouts that can meet and beat both inflation and taxes on an income and total return basis. That’s a hard combination to find in the current market, but as the saying goes, sometimes you’ve got to think outside the box.
All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.
Also In This Issue
A Look Ahead by Louis Navellier
The Fed Signals Another Rate Increase in 2023 (and No Cuts!)
Income Mail by Bryan Perry
Rising Bond Yields Stoke the Hunt for Maximum Income
Growth Mail by Gary Alexander
As We Approach $100 Oil (Again), Let’s Recall the 1970s Oil Crises
Global Mail by Ivan Martchev
Target for the Correction in Equities is Still the 200-day Moving Average
Sector Spotlight by Jason Bodner
If Volatility Makes You Seasick, I’ve Got the Right Antidote
View Full Archive
Read Past Issues Here
Bryan Perry
SENIOR DIRECTOR
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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