The Rationality of the Recent Market Sell-Off

The recent surge in the 10-year Treasury yield beyond 4% and the concurrent slump in utilities (XLU), banks (KRE), and precious metals (GLD)(SLV)(GDX) are a result of a mixture of hawkish comments from Federal Reserve officials and robust economic data indicating a potential persistence of inflation. As a consequence, numerous quality dividend stocks in these sectors are now available at reduced prices. We are capitalizing on this opportunity by acquiring more of these stocks as their prices continue to plummet.

In the following discussion, we will expound on why we believe that the ongoing sell-off may not be justified and will also unveil some of the utility/infrastructure, bank, and mining dividend stocks that we currently favor.

The Transient Nature of the Sell-Off

After Powell’s seemingly dovish stance in December engendered a Santa Claus rally, certain Federal Reserve officials have recently shifted to a more hawkish position on interest rates. For instance, Raphael Bostic, head of the Atlanta Fed, advocates the Fed policy rate reaching the 4.75%-5% range by next year, a level higher than the current market pricing. Other Fed officials, such as Loretta Mester, Christopher Waller, and Thomas Barkin, have also lately demonstrated a more hawkish leaning on interest rates.

Their stance has been bolstered by recent U.S. economic data, with inflation figures slightly moderating but still mostly exceeding the Federal Reserve’s 2% target. To illustrate, the Consumer Price Index (CPI) rose by 3.4% over the 12 months through December 2023, following a 3.1% increase in November. Furthermore, recent economic and market data suggest a period of steady but subdued economic growth in 2024, with recent consumption and jobs data surpassing expectations.

These factors have prompted a shift in market expectations, contributing to the recent upturn in Treasury yields and making dividend stocks, especially in bond substitute sectors like utilities, less attractive as the relative allure of their dividend payouts diminishes compared to the now higher yields offered by safer Treasury securities.

Nevertheless, we have several reasons to believe that interest rates are unlikely to remain elevated for long:

1. Corporate bankruptcies are on the rise, with 2023 proving worse than 2020. With a looming wall of corporate debt (particularly in commercial real estate) coming due soon, the Fed is likely to face pressure to cut rates to avert a severe recession.
2. The interest expense on the U.S. debt is becoming increasingly burdensome. With mounting pressure from increased military spending due to conflicts in Ukraine and Israel, alongside the geopolitical tensions with China, there will likely be significant political pressure on the Federal Reserve to ease its quantitative tightening program, notably during a major election year.
3. The Fed’s favored inflation metric – PCE – has been running below its 2% target for the past six months. While this duration isn’t sufficient to declare the fight against inflation won, it is long enough to infer that the Fed is close to achieving its objective of taming inflation.
4. Household balance sheets are under strain, with credit card debt at record levels. This implies that consumer spending is likely peaking and, in the absence of a rate cut, will likely start to recede shortly.
5. Several leading indicators, such as the Yield Curve Model and the State Coincidence Index Model, both indicate a high likelihood of an impending recession.

As a result, we anticipate the market sentiment will revert to prioritizing bonds (BND), precious metals, and defensive bond-like substitutes in the near future as investors become more inclined towards defensiveness rather than grappling with the prospect of persistently high interest rates.

Selections of Preferred Dividend Stocks

Given our perspective, we believe that the present moment presents an excellent opportunity to amass quality dividend stocks that have dwindled in recent weeks. Here are some of our favored options which we are accumulating during this downturn:

• Blue-Chip Miners Barrick Gold (GOLD) and Newmont Corporation (NEM) both possess robust investment grade credit ratings with minimal debt and substantial liquidity, ample tier-one assets, offer attractive dividends relative to their industry, and trade at substantial discounts on a P/NAV basis compared to peers. With significant multi-decade projections for gold and copper production for both entities, we see the current moment as an opportune juncture to accumulate their shares.
• Algonquin Power & Utilities (AQN) holds a solid BBB credit rating and owns high-quality utilities and renewable power assets. Furthermore, AQN is attractively priced with a dividend yield of over 7%. AQN’s management anticipates unlocking considerable value for shareholders by divesting its renewable power generation and development business this year at a value-accretive price and reallocating the proceeds towards debt reduction and substantial share repurchases. We have confidence in their ability to execute this plan, given that JPMorgan (JPM) conducted an extensive analysis of the company, not only recommending the sale of their renewables business but also providing a valuation range. Management has indicated that they are fielding promising offers from potential buyers, suggesting strong demand and interest in their renewables business. Additionally, activist investing group Starboard Value has been collaborating with the board and advocated ardently for the sale of the renewables business to unlock substantial value for shareholders. Since the announcement of the planned sale of the renewables business, Starboard has increased its position in AQN by a significant 71%, indicating confidence from an external investor with likely enhanced insight into the strategic review and sales process.
• Financial stock New York Community Bancorp (NYCB) combines an attractive current yield of ~7% with robust growth potential (analysts project a 6.9% CAGR in earnings per share through 2025). Furthermore, NYCB is undervalued relative 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.

Ruminations for Investors

Despite the recent stumble of defensively positioned dividend stocks, we believe they have rarely offered a more attractive risk-reward proposition than they do at present:

• Several factors suggest that the Fed is likely to be compelled to cut rates sooner rather than later.
• A looming recession makes defensive businesses increasingly valuable.
• Their valuations appear very appealing following the latest sell-off, particularly when compared to the overvalued S&P 500 (SPY) based on numerous metrics.

Consequently, we are amassing undervalued precious metals, utilities, and financial dividend stocks akin to the ones noted in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.