- The Power of 'Excess Liquidity' continues to drive the markets higher. I expect much more upside for the S&P 500 index, and our "model portfolio" in particular.
- Are we at "the beginning of the end of easy money"?
- Inflation is here. It's ugly. It's painful. But You Can Beat it and Make Money. I lay down the best sectors and stocks to do so.
- The situation with "Utilities Stocks". Why the pullback and is it a buying opportunity?
- The Best Course of Action for HDI Members in the current market environment, and my price target for the S&P 500 index.
The Power of 'Excess Liquidity'
Just last weekend, when most market participants were convinced that we were on the brink of a market correction, I highlighted the Power of Excess Liquidity. The Bubble of Liquidity demonstrated itself again this week when the markets surprised many investors by having one of the biggest rallies in months, delivering solid gains. The S&P index closed the week up 1.8%, its best week since last July. The Nasdaq was up by 2.2%, and the Russell small-cap index was up by 1.5%.
Weakness in equities continues to be quickly met with investors looking to "buy the dip". In a strong bull market like today, stocks can surprise to the upside at any time.
I have been urging members not to try trading this market as the risk of missing large rallies is high. Personally, I have been fully invested in the past several months and suggest that our members remain fully invested. Selling or reducing positions has been the wrong move. Furthermore, if you attempt to trade this market, it would result in significant missed opportunities when the markets recover quickly.
The Beginning of the End of Easy Money?
Last week, the biggest headlines in the news were proclaiming "The Beginning of the End of Easy Money". The reason? Fed tapering and higher interest rates are coming soon.
I would like to disagree with that statement for several reasons:
1. Tapering will be slow
By the end of this year, the Fed will begin to taper. This means that they will reduce their purchases of Treasuries and agency MBS. However, this does not mean that they will discontinue purchasing these assets.
Currently, the Fed is buying $120 billion/month in treasuries and MBS. "Tapering" means they might reduce that amount to "only" $100 billion/month. Then a month or two later, they might reduce it to $80 billion/month. The plan is not to stop buying assets. They will keep their monetary easing, support to the U.S. economy, and especially the stock markets. In fact, in the own words of Fed Chair Jerome Powell, the Fed will continue to support the economy and will not stop growing its balance sheet until well into the year 2022.
In my opinion, the Fed will easily continue growing its balance sheet until the year 2023. If you recall from my last week's market outlook, the Fed is not willing to take any risks. The Fed will do anything to prevent a stock market crash which could cause a recession in the United States.
If a recession hits, it will be much more costly for the U.S. to get out of a recession than to keep printing money and buying financial securities. A recession is the last thing the Fed wants, and we have the most dovish Fed that I have ever seen. It is not only the U.S. Fed that is following this policy, but also the European Central Bank and the Chinese central bankers, among others. This is a coordinated global effort.
The Fed will likely pause their tapering at any sign of weakness in the economy or the stock market. Maybe even go the other way and increase asset purchases. The odds are that the original timetable, which contemplates tapering being completed by mid-2022, will be extended.
2. Rate hikes delayed
Mr. Market is currently factoring in rate hikes in the middle to the end of the year 2022. This just is not going to happen. The Fed will wait for its tapering program to be complete, which, as noted above, is very likely going to be delayed. Plus, rate hikes will also risk a market crash. This is a very dovish Fed that has frequently erred on the side of easy money. That is not going to change.
Furthermore, the Fed is quite happy that inflation stays high because it is taking care of the enormous national debt and bank debts that could crush the economy. The higher inflation goes, the lower the value of these loans. Take an example: If you own a home valued at $200,000 and you have a mortgage on it of $100,000, as inflation hits higher, the price of assets goes up too. Your home could become worth $400,000, while your mortgage is still at $100,000. Therefore your leverage on your home is lowered from 50% to only 25%, which becomes much more manageable.
The same applies to banks and financial institutions, which are loaded with loans against assets as collateral. Should these loans remain this high, it could cause a big financial and banking crash that would result in an extremely painful recession that could take years to recover from. Furthermore, inflation increases GDP and results in a lower Debt/GDP ratio which is the ultimate goal of these Fed Officials.
3. Bubbles get "bubblier"
Historically, bubbles tend to get much larger than many expect before they burst. This one will be no different. Even as the Fed tapers, Governments across the globe are on a spending spree pumping more liquidity into the economy that is not needed. The U.S. is no exception as politicians toss around the word "trillions" without a second thought. Therefore even with the Fed tapering, the "bubble of liquidly in the system" will continue to get "bubblier". With a Fed being so dovish, an asset bubble burst is likely to take years before it happens.
We remain in a robust bull market that is primarily driven by excess liquidity. There is a mountain of un-invested cash sitting on the sidelines and looking for a place to park. The more liquidity in the system, the more asset prices (including stocks and real estate) will see their prices move much higher over the next two years at least. It is one of the best times to be invested in the equity markets!
Inflation is here. It's ugly. It's painful. But You Can Beat it and Make Money
All year the Federal Reserve has been claiming that inflation is transitory. Yet it seems that most of those Federal Reserve staff have either not been spending any time at grocery stores or buying consumer goods or just not telling us the truth and duping investors. I believe that the Fed is playing a cruel, sick joke to cover for their real agenda.
In each of my Sunday market outlook reports, I have been warning that inflation is set to increase going forward. It is very simple. Price increases take time to creep into the system, and the Fed figures are always backward-looking.
Inflation figures were released last week and rose again. In the 12 months through September, the CPI increased 5.4% after advancing 5.3% on a year-on-year basis in August.
- Food prices jumped 0.9% after increasing 0.4% in the prior month. The largest rise in food prices since April 2020 was driven by a surge in the cost of meat. There is more to come with pricing increases being discussed in earnings calls for companies like Hormel (HRL), PepsiCo (PEP), Kraft-Heinz (KHC). While changes in the prices of fresh foods tend to be volatile, changes in prices in preserved foods are much more sticky. These are pricing increases that are coming but are not yet factored into inflation.
- Owners' equivalent rent of primary residence, which is what a homeowner would receive from renting a home, increased 0.4%. That was the biggest gain in five years and followed a 0.3% rise in August.
- Rent of primary residence shot up 0.5%, the largest advance since May 2001.
When house and rental prices continue to pick up steam, this confirms that inflation is embedded in the system. Rents, which account for nearly a third of the CPI, will be a major source of inflation in the months ahead.
I explained that rents will take time to see inflationary pressures in September, and this phenomenon has just started. Food and rents accounted for more than half of the increase in the CPI, and when those increase, the vast majority never go back down.
Inflation is so sticky that "stagflation" has become a big topic among all banks reported this week. They are warning that inflation is not transitory.
As previously noted, inflation is indirect taxation that every one of us has to pay. This tax is heavier on the poor, middle class, and retirees for two reasons:
First, it is a flat tax that applies equally to all consumers, not based on income brackets. The lower your income, the higher percentage of your income you are likely to spend on various needs.
Second, the rich have more ways and means to protect against inflation. For example, quite a few of the rich are using "low cost" leverage of around 2% to invest 150% of their money in the stock markets or real estate. This is a way to beat inflation as short-term rates remain extremely low while house prices and the markets are soaring.
Furthermore, if you are a savvy investor, you can buy commodities, real estate, floating-rate debt, and other investments that provide excellent inflation protection. Much of the population cannot do so either because they do not have the capital or do not have the knowledge. Our strategy at HDI is to protect ourselves with investments that benefit from inflation, and we are sharing that knowledge with you.
So prepare for high inflation, and keep yourself invested to protect the purchasing power of your hard-earned savings!
Stagflation has been one of the most searched words on the internet this past month. It has become increasingly talked about on earnings calls and in the financial press.
We see some signs that elevate the risks of stagflation. For example, the extended climb in oil prices and other industrial commodities is a classic red flag. These prices can create external pricing pressure on the economy, as we discussed a month ago.
Crude oil prices climbed over the past year by roughly 100%. For the same period, natural gas prices increased by roughly 100%, coal prices by 300%, and NGLs (natural gas liquids) prices by 100%. Energy-price increases were a wake-up call for markets, and the scenario that's now more likely to develop is one in which we get higher inflation and weaker output.
Iron ore has suddenly gone from commodity laggard to a top performer, with resurgent prices further sparking inflation fears rippling across the world. Iron futures have climbed 50% in just three weeks, joining gains in aluminum as stalled supply lines and climate policy send an index of raw materials to the highest ever. Even cotton prices are up 25% since Sept. 20.
With inflation running high and a shortage of many commodities, we might face the risk of stagflation in a few years. Stagflation is when inflation runs higher than GDP growth. This means that no matter how well a company is doing or how much wages workers earn, stagflation will eat away their purchasing power as costs rise faster than earnings.
If we face such a situation, the Fed and the government will have very few tools to fight it. Stagflation can be extremely painful to get out of and will result in a massive recession.
For those who remember or read about the last stagflation we had in the 1970s, the U.S. endured 9% unemployment, a contracting economy, and double-digit inflation. Stagflation is an old ghost rising from the past for those who lived it and survived it.
The good news is that many of the same stocks that investors can buy to do best in a stagflation environment are very similar to the ones we are recommending today to fight inflation. A portion of our portfolio is already positioned to battle this threat.
Businesses are still expanding, unemployment is relatively low, and there is no shortage of jobs. We don't want to cut ourselves short by being too defensively positioned and miss out on the economic expansion. Right now, we have economic growth and inflation. Stagflation won't come until the economic expansion slows.
However, when we reach closer to stagflation, we will have to get more aggressive with commodities/energy, select REITs, floating-rate financials, and other stocks that can beat stagflation even better than those that would beat inflation.
Don't Fear Inflation: Fight Back!
So what is the best way to fight off inflation, protect your purchasing power, and even make money out of it? At HDI, we like to fight it with different sectors that do well in today's environment.
- Cyclical and Small Cap Stocks: The leaders over the next 12 months at least will be Cyclical stocks and smaller-cap value stocks. We particularly like small caps, which are more tied up to U.S. GDP growth, and benefit more from CAPEX cycles and a "red hot" economy. Such stocks are highly correlated with commodity inflation. Furthermore, many small-cap stocks are "value stocks" and trade at a historical discount vs. large caps. History tells us that smaller cap stocks do much better during periods of inflation. At HDI, we have handpicked such stocks to leverage on a red-hot economy.
Commodities: From a sector perspective, we very much like exposure to commodities. Higher energy and commercial metal prices are often associated with rising inflation. Commodities are also great to hold in case we get into a "stagflation" cycle as they tend to shine during such a period. We will continue to identify dividend opportunities in this sector.
Banks and Financials: As we see today, when inflation hits, long-term interest rates tend to rise, and then short-term interest rates follow. This would benefit the financial sector such as Banks, BDCs, and several mortgage REITs.
Property REITs: Property REITs are a diverse mix of industries, but given we are seeing a rise in rents and a shortage of supply in housing and areas such as cell towers, they have pricing power. These REITs benefit from inflation driving rent up while having very few expenses exposed to inflationary pressures. Property REITs is another area that should benefit.
- Select Bank Loans:Bank loans, senior secured debt, or commercial mortgages that frequently reprice with short durations or floating rates will outperform as rates rise.
Importantly, high-dividend stocks, such as the ones we target at HDI, are your best hedge against inflation and help beat inflation by generating income.
This is especially true if you are invested in super high dividends of +7%. If you invest with yields of 7% and reinvest your dividends, not only are you are beating inflation, but you are boosting your future income, and you are setting yourself up for success when inflation gets back under control in a few years. You will have excess income to spend and reach a happy, comfortable retirement that will exceed your income needs.
Some of my favorite super high yielders include:
- Oxford Lane Capital (OXLC) yields 10.6%
- Eagle Point Credit (ECC) yields 10.2%
- XAI Octagon Floating Rate & Alternative Income (XFLT) yield 10.1%
- PIMCO Corporate & Income Opportunity Fund (PTY) yield 7.9%
- PIMCO Dynamic Income Opportunities Fund (PDO) yields 6.6%
Other individual stocks that I particularly like are:
- Annaly Capital (NLY) yields 10.3%, and AGNC Investment Corp (AGNC) yielding 8.9% are two of the best-managed agency mortgage REITs. These are two great inflation beneficiaries that are set to benefit from higher long-term interest rates.
- John Hancock Financial Opportunity Fund (BTO) yields 5.1%, is a CEF that invests in large and small banks. Banks are in the same situation as NLY and AGNC above and are set to thrive as interest rate spreads widen. This is exactly the reason why banks soared this week, even after reporting lower-than-expected earnings. The markets are forward-looking and we are set to see very solid earnings in these financial stocks over the next quarters.
- Within the energy sector, Enterprise Products Partners (EPD) yielding 7.4%, and Antero Midstream (AM) yielding 7.9%, provide great exposure to both Natural Gas and Natural Gas Liquids ('NGLs'), which offer one of the best hedges against inflation. Blackrock Energy & Resources Trust (BGR) yields 4.4%, which is also a great CEF to get exposure to the large integrated oil companies and energy producers.
BlackRock Resources & Commodities Strategy Trust (BCX) Yields 5.0% and provides immediate and diversified exposure to commodities, including commercial metals, agriculture, precious metals, and energy.
- Capital Southwest Corp. (CSWC) yielding 8.7%, TriplePoint Venture Growth (TPVG) yielding 8.6%, Ares Capital (ARCC) yielding 7.8%, are three Business Development Companies that operate in the financial sector. They invest in small and medium businesses that are set to be the biggest beneficiaries from a red hot economy.
- Ares Commercial Real Estate Corporation (ACRE) yields 9.0%, and as a commercial mREIT, ACRE is well-positioned for rising rates. Over the next year or so, you will see us increase exposure to the commercial mREIT sector as we prepare for an eventual raise of the Fed's target rate.
- Cohen & Steers Quality Income Realty Fund (RQI) yields 6.0%, and AWP (AWP) yields 7.5%. Both provide immediate diversification in the Property REIT sector. Note that AWP is currently trading very cheaply and provides a great buying opportunity.
Finally, I would like to remind our members to keep a high allocation to fixed income (up to 40%), including preferred stocks, baby bonds, and fixed income funds. If you like instant diversification, Virtus InfraCap U.S. Preferred Stock ETF (PFFA) yields 7.6%, and Flaherty & Crumrine Dynamic Preferred & Income Fund (DFP) yields 6.8%, are two great choices. Those will help to keep your portfolio with lower price volatility.
The Situation with Utilities Stock
I have had many questions from our members about the situation with utilities while heading into higher inflation, and in particular, our positions in Reaves Utility Income Fund (UTG) yield 6.9%, and Cohen & Steers Infrastructure Fund (UTF) yield 6.7%. We saw these two great CEFs decline in price, and I believe it is a knee jerk to higher treasury yields.
However, I remain very bullish on the outlook of these funds. Keep in mind that so much investor money is currently parked in Treasuries or sitting at the banks receiving negative real yields.
Earlier this year, we saw huge demand for utility funds as investors shifted from Treasuries, CDs, and money markets to buy utility stocks. Remember, utilities are a proxy to bonds. This is a defensive sector that tends to generate great income in both good and bad times. UTG and UTF invest in electricity, water, infrastructure, telecom, internet, road, and rail. All these investments have inelastic demand and are in need no matter what the economy does.
Furthermore, investing in utilities provides not only steady and reliable income, but also some growth. With the planned new infrastructure spending, UTG and UTF should be big beneficiaries. So I believe it is only a matter of time until investors start loading up on utilities in general, driving UTG and UTF higher. This pullback is a buying opportunity, and I am personally buying the dip.
The Technical Picture
With the markets proving to be so resilient, I expect to see new all-time highs very soon. However, above-average volatility is likely to remain with us for some time, which is great as it creates some excellent buying opportunities.
I expect the S&P 500 index to reach the 4600 level (or 2.8% higher from here) in the next 3 to 6 months, possibly even sooner. My target is at least the 4900 level for the index by the end of 2022 (or a minimum of 9.5% higher from here).
On the downside, the 4400 level has proven to be a solid support level, followed by the 4250 level, which I believe to be the "floor" for this market. I continue to view every pullback as a buying opportunity!
Note that the last quarter of the year has historically been the strongest, and I expect to see the same this year. Investors will adjust to a more bullish tone as we head towards the Christmas holiday season. Additionally, the rotation to value is likely to continue gaining steam, and value stocks will outperform growth stocks.
The Best Course of Action for HDI Members
For those members who are fully invested, like myself, my best suggestion is to remain so and keep collecting our big dividends—reinvesting the dividends you can whenever the market has a red day. The big bubble of liquidity will continue to support this bull market and drive stock prices much higher. There is still a huge upside left, in addition to our recurrent income.
I suggest using pullbacks to buy stocks for members who are still sitting on large amounts of cash. Our HDI positions have been carrying much lower price volatility than the markets in general, including the S&P 500, the DOW, and the Nasdaq. Still, on some days, we get pullbacks in our high-yield stocks. These pullbacks are the best time to "load up on these stocks"! I would avoid getting excited and avoid buying stocks during strong up-days. When your brokerage account is red, shop for deals. When it is green, take the day off. This is the best way to lock in higher yields and maximize your future capital gains.
I always like it when the markets close on Friday with a strong note. This indicates that smart investors are comfortable holding stocks over the weekend and confirms that we remain in a strong market. Again, keep in mind that the last quarter of the year has historically been the best one for equities. I am very excited about the prospects of stocks in general and our HDI stocks in particular. The future is looking bright!
Have a great Sunday!