3 Stocks For A Lower-For-Longer World

The market has been intensely concentrated all year on the Federal Reserve’s plan to increase interest rates. That focus has weighed on rate-sensitive sectors and threatened to drive investors back into bonds for income.

We are quickly approaching the September 19 meeting of the Federal Open Market Committee (FOMC), one of the last three meetings of the year. 

While investors aren’t expecting the Fed to raise rates at the coming meeting, they’ll be watching intently for any clues on future policy. Much of the market has been expecting the Fed to make good on its forecast of three rate hikes this year by raising rates in December.  

However, there’s mounting evidence though that could lead the Fed to hold off on its path to higher rates. This economic evidence could be called out in the September press conference. Dovish language from Chair Janet Yellen about future rate hikes could mean a surprise boon for rate-sensitive sectors and stocks.

Higher Rates Face Headwinds From Hurricanes, Fed Vacancies, And Inflation
The market is estimating a 32% chance the Federal Reserve raises its benchmark target rate in December, according to the FedWatch Tool by CME Group. That’s down from 47% a month ago but still a strong expectation for higher rates. More than half of participants expect interest rates to be higher by this time next year.

#-ad_banner-#Against the vigil for higher rates, evidence that rates will stay lower for longer is mounting.

The impact of at least two devastating hurricanes will weigh on the economy in the third and fourth quarter. While rebuilding and public spending could boost economic growth, it will take some time before the effects are felt.

Hurricane Harvey has already affected employment numbers, with initial jobless claims spiking 62,000 in the week after the storm’s landfall. The increase in first-time filers for unemployment represented a surge of 26% from the previous week and the highest in nearly two years. These numbers are only expected to get worse as Hurricane Irma strikes in the east.

Houston is the country’s fifth-largest metropolitan area and home to a significant percentage of the country’s chemical and energy industries. Those industries were completely paralyzed during the storm and it will be weeks before they are fully operational. The economic impact on the household side could be even heavier. More than 12 years after Hurricane Katrina, New Orleans’ nonfarm payrolls are still 7% lower than pre-storm levels.

While rebuilding efforts may eventually support economic growth, the massive devastation may give the Fed reason to pause through the rest of the year.

The early resignation of Vice Chair Stanley Fischer, as well as other vacancies at the Federal Reserve, gives President Trump a lot of power to shape the group that controls monetary policy. Trump has said he favors a weaker dollar to boost trade and could look to fill positions with people unlikely to raise rates that could weigh on borrowing.

Along with these recent headwinds to expectations for higher rates, inflation is still nowhere in sight. Fed Governor Lael Brainard pointed to persistently low inflation as a reason to hold off on raising rates in a speech to the Economic Club of New York last week. The permanent voting member of the FOMC also said that Hurricane Harvey raised uncertainties for the economy.

Sectors And Stocks That Could See A Surprise Upside
This lower-for-longer scenario could come as a surprise upside for rate-sensitive sectors and stocks. Besides the potential for low short-term rates, long-term rates have also come down recently and are breathing new life into heavily leveraged sectors.

That upside could come through with positive outlooks when companies start reporting their third-quarter earnings next month.

Utilities benefit from lower rates on low borrowing costs and as their high yields attract bond investors. When the rate on the 10-Year Treasury surged a full percent over the last six months of 2016, the Utilities Select Sector SPDR ETF (NYSE: XLU) underperformed the broader S&P 500 by more than 16% over the period.

Dominion Energy (NYSE: D) is more diversified than your typical utility, with strong cash flows in natural gas storage and pipeline transmission. The company is also constructing an LNG export facility to complement its business in regulated gas and electric generation. Dominion pays an attractive 3.9% dividend and has increased its per-share payout by 8% annually over the last three years.

A strong catalyst for Dominion is the potential approval of its Atlantic Coast Pipeline after the Federal Energy Regulatory Commission (FERC) finally reached full quorum with the appointment of two more members in August. The two Republican appointments make it likely the pipeline will be approved. When completed, the project should support strong cash flow to Dominion Energy and its master limited partnership unit, Dominion Midstream Partners, for several years.

Real estate investment trusts (REITs) tend to be some of the most highly-leveraged companies, borrowing heavily to finance property purchases and developments. To protect their status and avoid corporate taxes, REITs must pay out over 90% of income which means they are heavily dependent on borrowing to pay for growth and key beneficiaries of low rates.

Vornado Realty Trust (NYSE: VNO) spun off its Washington, D.C. assets in July in a move to dramatically improve its balance sheet and is now almost entirely focused on the Manhattan area. The company owns mostly Class A properties with vacancy rates below 5%, along with a smaller portfolio of properties in Chicago and San Francisco. The company pays a 3.3% dividend and has increased its per-share payout by 3.9% annually over the last three years.

Vornado owns nearly 7.0 million square feet of office and retail space just east of the upcoming Hudson Yards development project, a $20 billion development that is expected to become one of Manhattan’s highest-growth areas. The increased foot traffic and development should help boost rental rates for Vornado’s properties as well.

Boston Properties (NYSE: BXP) primarily owns office properties in New York, Boston, San Francisco and Washington, D.C., though it has recently expanded into Los Angeles. The company pre-leases its developments before starting construction, which takes some risk out of large projects. Boston Properties pays a 2.5% dividend and has increased its per-share payout by 4.8% annually over the last three years.

The company has a promising 6.1 million square feet of space in development with 75% pre-leased. That increases its leasable space by 12% and is just part of its planned 13.5 million square feet in near-term development starts. Upcoming developments could give Boston Properties more efficient scale and support cash flow to shareholders.

Risks To Consider: Any fiscal stimulus from tax reform or infrastructure spending, or the eventual rebound from emergency rebuilding, could give the Fed reason to resume its rate hikes. 

Action To Take: Position in rate-sensitive sectors like utilities and REITs for a surprise upside as the Fed pauses its rate increases through the year.

Editor’s Note: With the Dow surging to new highs and companies booking clockwork triple-digit gains, it’s time to position your portfolio for a new generation of 10 Top Stocks that you simply MUST own. Get the FREE report here.