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Will Treasury Yield Inversion Benefit Stocks? 5 Top Picks

Nalak Das

Wall Street is currently reeling under the inverted yield curve of U.S. Treasury Securities. The bond market scenario, which showed its ugly face on Aug 14, has worsened thereafter compelling several economists and financial experts to warn for a possible recession in the U.S. economy.

However, there still exists a ray of hope even under a cloudy financial market landscape. On Aug 27, Paul Hickey, co-founder of Bespoke Investment Group, pointed out that yield on long-term, 30-year U.S. Treasury Note has fallen even below the dividend yield of the S&P 500 Index, popularly known as the benchmark index of equities.

Stock-Bond Yield Inversion Likely to Benefit Investors

On Aug 27, the yield on long-term, 30-year U.S. Treasury Bond fell to 1.916%, below the S&P 500’s dividend yield of an estimated 1.94%. However, the yield on the 30-year Note later stabilized at 1.961%. Again, on Aug 28, the yield on 30-year Note sild to its all-time low of 1.907% and recovered only to 1.942% at the closing of the day.

The inversion of long-term government yield with the dividend yield of the broad-market index of equities is likely to make equities more attractive alternatives. Intensifying trade conflict with China and fear of a global economic slowdown, especially in Eurozone and China, have significantly dented investors’ confidence.

However, in their rush to pour money to safe-haven government bonds from risky equities, market participants have shifted too much money to the bond market resulting in plunging yields. At this juncture, any company, which has a history of paying out regular dividend, with higher dividend yield than the yield of 30-year U.S. Treasury Note, will be a more preferable asset for investors.

Is Recession Impending or Overblown?

On Aug 14, yield on the benchmark 10-year Note dropped to 1.623%, which fell below the 2-year Note’s yield of 1.634, for the first time since December 2005. Thereafter, the situation worsened further. On Aug 28, yield on the 10-year Note plummeted below the psychological barrier of 1.5% to 1.45%, below the 2-year Note’s yield of 1.5%. The spread registered its lowest level since 2007.

Meanwhile, the yield on short-term 3-month Treasury Bill stayed at 1.992%, reflecting inversion with the yields of mid-term 2-year, benchmark 10-year and long-term 30-year Notes. In fact, inversion between 3-month and 10-year bond yield is continuing since March 2019. At present, this inverted spread is for more than 54 basis points, its highest since March 2007.

The yield curve of government bonds are generally upward sloping, implying that a higher rate of interest is needed for individuals to hold longer maturity bonds. However, an inverted yield curve is generally characterized as market’s diminishing expectations about future economic growth. CNBC stated that since 1978, there were five yield inversions between 2-year and 10-year Notes, all of which led to a recession.

However, several economists and financial experts have pointed out that the fundamentals of the U.S. economy are still strong to cope with any recessionary signal. While some economic data, especially for the manufacturing sector, indicated that business investment has slowed down due to a lingering tariff war, several consumer-centric data like consumer confidence and retail sales clearly highlighted economic stability.

Moreover, the U.S. labor market remained simply robust with strong job additions, steady wage growth and record-low unemployment. Meanwhile, the second-quarter 2019 results were far better than expected at the beginning of the reporting cycle, albeit with a dip in profit margin.

Our Top Picks

At this stage, investment in high-yielding, S&P 500 stocks which pay out regular dividend will be a prudent move. However, the selection process may be difficult. Our VGM Score will come in handy to select proper stocks.

We narrowed down our search to five such stocks each carries either a Zacks Rank #1 (Strong Buy) or 2 (Buy) and have a VGM Score of A or B. You can see the complete list of today’s Zacks #1 Rank stocks here.

The chart below shows price performance of our five picks in the past six months.

Bristol-Myers Squibb Co. BMY discovers, develops, licenses, manufactures, markets, distributes and sells biopharmaceutical products worldwide. The company offers drugs in oncology, immunoscience, cardiovascular and fibrotic diseases. It sports a Zacks Rank #1 and has a VGM Score of B.

The company has expected earnings growth of 7.5% for the current year. The Zacks Consensus Estimate for current-year earnings has moved 0.5% north over the last 30 days. Bristol-Myers Squibb offers a current dividend yield of 3.4%.

ONEOK Inc. OKE is engaged in the gathering, processing, storage and transportation of natural gas in the United States. The company operates through the Natural Gas Gathering and Processing, Natural Gas Liquids, and Natural Gas Pipelines segments. It carries a Zacks Rank #2 and has a VGM Score of A.

The company has expected earnings growth of 11.5% for the current year. The Zacks Consensus Estimate for current-year earnings has moved 1.3% north over the last 30 days. ONEOK offers a current dividend yield of 5.2%.

Verizon Communications Inc. VZ is one of the largest communication technology companies in the world. The company offers communications, information and entertainment products and services to consumers, businesses and governmental agencies worldwide. It has a Zacks Rank #2 and VGM Score of A.

The company has expected earnings growth of 1.9% for the current year. The Zacks Consensus Estimate for current-year earnings has moved 1.1% north over the last 30 days. Verizon Communications offers a current dividend yield of 4.2%.

Principal Financial Group Inc. PFG provides retirement, asset management, and insurance products and services to businesses, individuals and institutional clients worldwide. The company operates through Retirement and Income Solutions, Principal Global Investors, Principal International and U.S. Insurance Solutions segments. It carries a Zacks Rank #2 and has a VGM Score of A.

The company has expected earnings growth of 6% for the current year. The Zacks Consensus Estimate for current-year earnings has moved 3% north over the last 60 days. Principal Financial Group offers a current dividend yield of 4.1%.

Omnicom Group Inc. OMC provides advertising, marketing and corporate communications services. The company provides a range of services in the areas of advertising, customer relationship management, public relations and healthcare. It has a Zacks Rank #2 and VGM Score of B.

The company has expected earnings growth of 5.2% for the current year. The Zacks Consensus Estimate for current-year earnings has moved 18.5% north over the last 60 days. Omnicom Group offers a current dividend yield of 3.5%.

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ONEOK, Inc. (OKE) : Free Stock Analysis Report
 
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