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4 Ways to Play Low Interest Rates

Jeff Remsburg

Three of our analysts point toward a specific approach for today’s market environment

As I write, the CME Group’s FedWatch Tool puts a 95.8% chance on the Fed lowering rates by a quarter-point by the September 18 FOMC meeting.

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Plus, we already have a small-yet-growing chorus of analysts suggesting that U.S. rates will eventually drop to zero.

Meanwhile, the spread of negative-yielding sovereign bonds around the world continues. The cumulative value of such negative-yielding assets has pushed north of $16 trillion. In fact, if you exclude the U.S., nearly 45% of the worlds’ bonds now have negative yields.

Here’s a snapshot of where yields are on some of the 10-year European debt.

As we explained in a recent Digest, these negative rates are resulting in “capital flight” — basically, a rush of foreign wealth pouring into the U.S. Treasury market since it still offers comparatively high interest rates relative to these negative foreign yields.

But as more foreign money floods the U.S. market, it pushes down our Treasury yields … closer and closer to zero.

Recently we’ve seen several yield curve inversions as longer-term rates have fallen. This is bad for banks which rely on a healthy spread between short-term and longer-term rates to generate profits.

So, these inversions put pressure on the Fed to lower short-term rates again to prevent additional inversions. That brings us back to the 95.8% odds from above that we’ll get another rate cut by the September 18 FOMC meeting.

Now, low rates from the Fed can be great for a person who needs a mortgage (the 30-year fixed-rate mortgage averaged 3.6% during the week ending Aug. 15. The last time mortgage rates were lower was in early November 2016). But they make investing far more challenging for income investors.

Meanwhile, let’s not forget recent market volatility.

Fireworks filled last Friday after trade war escalations sent the stock market reeling. And as we’ve noted here in the Digest, some of the brightest minds in investing believe the markets are nearing an inflection point that will send us into whatever market-environment will follow this historic bull run.

So, how can we respond? What’s an effective market strategy given that we’re living in a “bizarro world” of negative interest rates around the world, historically-low rates in the U.S., and a stock market with a murky future?

Perhaps the answer isn’t all-that complicated … look for quality companies that pay attractive dividends.

It turns out that John Jagerson, Louis Navellier, and Neil George all independently pointed toward this market approach recently. So, today, let’s look at the market through their eyes. When we do, we’re going to find a solid defensive strategy that’s been paying off nicely while the markets have been wobbling.

***Why quality dividend investments should perform well

Let’s begin with John Jagerson of Strategic Trader. John is our resident quant analyst, using historical market data to identify patterns and trends that help guide his investment decisions.

John starts by explaining why interest rates have a big effect on dividend investment valuations:

Stocks that pay attractive dividends are usually valued on two factors. First, does the fundamental performance of the company predict that those dividends will continue to rise in the future. And second, are interest rates falling or rising.

The second factor may be a surprise but, like bonds, rising interest rates lowers the present value of future dividend payments and lower rates increase their value.

The following chart should make this relationship a little easier to visualize. I have compared the SPDR consumer staples sector ETF (XLP) which is comprised of big dividend paying consumer stocks, with the 10-year bond yield.

As you can see, XLP matched its prior all-time highs this month. It also fell 40% less than the S&P 500 did on Friday.

This is largely possible because of the value of the dividends paid by the components of the index. This is one of the big reasons we include an analysis of dividends in the stocks we select in our Strategic Trader service.

Now, with this relationship between interest rates and dividend investments behind, what is John looking at right now?

After languishing over the last few years, I think there is some short-term opportunities to take advantage of the flow of capital into real estate investments this year.

I have included a chart of the Vanguard Real Estate Investment Trust ETF (VNQ) below; right now, it looks a lot like it did in 2010. Performance has been better recently than the S&P 500 and bargain hunters kept losses limited compared to the major indexes last Friday.

You could play REITs using VNQ itself. But John highlights a specific REIT you might want to investigate.

This could be the perfect market situation for REITs that specialize in storage units like Public Storage (PSA) and similar companies as a market downturn could kick up demand for storage units next year which may extend the value of this kind of REIT despite a potential downturn in the market.

If you’re less familiar with PSA, look at its chart below, year-to-date. While the S&P is up 14%, PSA has more than doubled that return. Take special note of the divergence since late-July, when the S&P has fallen at the same time PSA has shot higher.

If you want to read more from John as to where he sees the market going, click here.

***Meanwhile, Louis Navellier is also looking at quality dividend investments

Famed investor, Louis recently penned a note to subscribers that highlighted a different type of dividend investment — utilities.

From Louis:

Utility stocks certainly come to mind as a “boring” investment. But their high dividends are anything but. You can often make 2.5%, 5% or more in dividends from utilities … far more than from most other sectors. (And given the central banks’ penchant for rate cuts, that goes for bonds, too.) That’s why utilities are usually favored by folks investing for their golden years, as these stocks provide extra income.

Louis goes on to note that, according to CNBC, at times when the S&P 500 fell at least 10% in one month during the market’s 11-year bull run, the best-performing sector was utilities.

And market volatility isn’t the only reason to consider utilities. As we mentioned at the top of this Digest, we’re dealing with incredibly low rates today. Here’s Louis on why that might benefit solid utility companies:

The truth of the matter is that not only do utilities provide safe havens during bouts of market volatility, but the ultralow interest rate environment is great for them, too. Borrowing costs are lower, and they can retire higher cost debt and replace it with lower cost debt. This means any more debt they take on is at a lower cost, which can help boost operating margins.

So, how might you play utilities? Well, there’s the utility ETF, XLK. As you can see below, it’s up nearly double that of the S&P here in 2019.

But Louis also points toward one specific utility he likes — NextEra Energy (NEE).

Back to Louis:

NextEra Energy is currently the largest utility company in the world. Through its two electric companies in Florida, a renewable energy business and several subsidiaries, NextEra Energy provides electricity, wind and sun energy, battery storage and nuclear power. The company began operations back in 1925 as the Florida Power & Light Company and operated gas plants, power plants and water facilities, as well as laundry and ice cream businesses.

Louis then walks readers through his Portfolio Grader. Here’s how it looks:

A note from Louis about its Fundamental Grade:

Though its Fundamentals hold a C-rating, what’s really important is that its Quantitative Grade is an “A.” It’s the most powerful variable in my grading stock formula, as it indicates the current level of buying pressure.

NextEra is a company Louis considers a “Bulletproof” stock, which simply means it will do well no matter which way the market turns, primarily thanks to its strong earnings growth.

If you’d like to learn more about Louis’ other Bulletproof stocks, click here. They’re a select group of special stocks that have continued to perform well while the broader market has stumbled.

***It turns out Neil George likes both NextEra and REITs

Neil is a master income investor who specializes in finding high yields from quality investments in his newsletter, Profitable Investing.

In a recent update to subscribers, he set the stage for his focus on quality dividend companies:

… trade risks and the global economic slowdown are still causing trouble in the U.S. stock market … This means that the safest opportunities remain in U.S.-focused industries and sectors, preferably with higher dividend-paying stocks. This comes from me, a guy who has focused his entire career on global investing, trading and asset management.

Like John, Neil points toward REITs as an attractive sector:

Real estate investment trusts (REITs) remain one of the better performers in the U.S. market. REITs have outperformed the S&P 500 Index by nearly three times over the past year.

Bloomberg US REITs Index vs. S&P 500 Total Returns –Source: Bloomberg Finance, L.P.

In Neil’s most recent issue of Profitable Investing, he explained why REITs are benefitting from lower rates:

Regarding real estate investment trusts (REITs), lower rates make for lower interest costs, and the bigger tax-advantaged dividends are worth more with lower inflation and lower market yields.

Let’s now jump back into Neil’s update from mid-August. Here, he pivots, turning his attention to utilities. Like Louis, Neil sees them outperforming:

But REITs aren’t the only U.S.-focused sector that’s benefiting from U.S. growth. U.S. utility stocks continue to outperform, generating returns nearly triple those of the S&P 500 Index, year over year.

S&P 500 Utilities Index vs. S&P 500 Total Returns — Source: Bloomberg Finance, L.P.

As to the specific utility Neil likes? He also points toward NextEra Energy. In fact, Neil recently raised his buy-up-to price on NEE to $216.

Since that update, NEE has continued pushing higher, now trading at a 52-week high of 224.54. Look for a pullback if you want to get in below Neil’s suggested price.

Neil has a several additional quality dividend and income plays in his Profitable Investing portfolios that will perform well as rates fall. To learn more, click here.

Wrapping up, when three of our analysts independently highlight a market approach (and two of our analysts both like a specific investment), we take notice. If REITs and utilities haven’t been on your radar, give them a look today.

Have a good evening,

Jeff Remsburg

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