WANAN YOSSINGKUM
WANAN YOSSINGKUM
As someone who invests primarily in interest rate-sensitive high-yielding dividend stocks, the most frequent question that I receive from fellow investors is when I think the Federal Reserve will cut interest rates. In this article, I will provide a quick recap of how my portfolio has fared over the past 12 months in the face of interest rate headwinds and then share my macroeconomic outlook for the next 12 months, particularly as it pertains to if and when the Fed will cut rates.
While I have been blessed with substantial long-term outperformance of the S&P 500 (SPY), the past twelve months have been perhaps the most challenging period for my investment portfolio since I began investing seriously about 15 years ago (shortly after the Great Financial Crisis).
Moreover, while I definitely have had some strong performers during that period and successfully took advantage of unwarranted market panics regarding some individual stocks (two recent examples that immediately come to mind are the sell-off in Blue Owl Capital (OWL) last May when I bought it heavily on the dip to around $10 per share and my aggressive purchases of Brookfield Infrastructure Partners (BIP) in October when it dipped heavily due to the release of a short report and concerns about rising long-term interest rates), I also had some very ugly losers such as NextEra Energy Partners (NEP), which proved to be extremely sensitive to its cost of capital (a mistake on my part as I did not properly take into account their complex financing scheme when assessing their balance sheet) and New York Community Bancorp (NYCB) (this one was more of a random event situation as it blindsided virtually every analyst as well as prominent investors like George Soros).
Another headwind for my portfolio was that interest rates appear set to remain higher for longer than I originally anticipated, which is a negative for the valuations of businesses that generate stable cash flows with long-term contracts and/or regulatory agreements in place.
That being said, my BDCs (BIZD) and midstream businesses (AMLP) overall have done quite well despite these headwinds, helping to alleviate some of these challenges. Moreover, as a long-term-oriented and income-focused investor, I am not overly focused on trying to time macroeconomic events and am certainly not concerned by a single year of poor stock price performance in my portfolio. In fact, I actually outperformed the broader U.S. high-yield space, as evidenced by the -6.10% total return generated by the Global X Super Dividend U.S. ETF (DIV) and the -3.93% total return generated by the SPDR Portfolio S&P 500 High Dividend ETF (SPYD) over that same period.
Moreover, my International Portfolio - which is run with the same strategy as my Core Portfolio - had a pretty strong year, delivering 10.3% total returns from February 1st, 2023 to February 1st, 2024 compared to a 1.27% total return for the international high-yield as depicted in the iShares International Select Dividend ETF (IDV) during that same period.
With that in the rearview mirror, here is what my front windshield looks like right now:
Market sentiment right now seems to be primarily dominated by the following trends:
As a computational engineer by training with a degree of specialization in machine learning and deep learning (the main technologies underpinning what we more broadly refer to as "artificial intelligence"), I completely agree that A.I. is a legitimate transformative technological revolution that is very likely going to radically change how we live our lives in the coming decades. However, I have had success in the past as a dividend investor, and have built my investing knowledge around this approach through years of working as an analyst for various dividend investing research companies, so I am not going to ditch dividend/value investing to chase the latest fad where anyone can look like a genius (or not) by trying to time short-term market sentiment shifts.
That being said, I also am a believer in diversification, so for sectors such as technology and healthcare/biotech where I do not spend much time doing my own research, I simply invest in ETFs to gain exposure. Personally, I focus my coverage on where I believe I can actually add value and long-term total return outperformance relative to high-yield stock funds such as the Schwab U.S. Dividend Equity ETF (SCHD), DIV, and IDV.
As far as the second dominant market trend right now, I am not in the business of making short-term macroeconomic calls, nor am I trying to completely focus my portfolio on riding short-term macroeconomic waves. With that being said - and while I expect the official narrative from the current administration and from much of the media to remain positive on the economy during this election year - I remain pessimistic that the economy will be able to completely avoid a recession over the next few years for the following reasons:
1. Virtually the entire developed global economy is either technically in a recession (i.e., the U.K., Europe, and Japan) or dealing with major economic challenges and soaring unemployment (i.e., China). Given how interconnected we are with these economies, the impact that their economic challenges will have on us is hard to overstate.
2. Leading recession indicators - such as the Yield Curve Model - show that we remain at a "Very High Risk" of going into recession soon.
3. Numerous cracks are forming in our economy, such as the growing challenges plaguing the commercial real estate sector (just ask NYCB shareholders about this one!), repeated announcements of significant layoffs at various companies, and the record levels of consumer and corporate debt. While stronger-than-expected consumer spending has propped up the economy (and inflation) so far, the data seems to be pointing to the fact that their capacity for further spending is running low, and - with leading foreign economies already in downturns - we cannot expect a boost in foreign demand for our goods and services to prop us up either. Even the labor market appears to be finally weakening.
4. The full impact of rapid interest rate hikes often takes a while to be fully reflected in economic data, and the longer the Fed keeps interest rates elevated, the greater the risk that this full impact will manifest itself in a very negative way for the economy.
5. Last, but not least, the market seems to be largely ignoring the growing geopolitical risks facing the global economy, especially in the Middle East and East Asia. If Iran were to get embroiled directly in the ongoing conflict between Israel and the United States against Hamas and the Houthis, it could cause a significant economic shock that may tip the U.S. into recession. Far worse, if North Korea were to formally reignite its war with South Korea - a leading global economy - and/or if China were to take action against Taiwan via a direct invasion or even simply a blockade, it would likely have disastrous effects on the global economy and send us into a deep recession or even a depression.
This leads me to the third and final major market trend right now. When you combine these aforementioned macroeconomic and geopolitical risks with the facts that:
it appears more likely than not to me that any one of these numerous factors will impact the economy and/or inflation numbers in such a way that causes the Federal Reserve to cut interest rates several times this year and next year. That said, I would not expect them to cut until June at the earliest, and - should inflation remain sticky and the economy remain on somewhat solid footing until then - they may delay until shortly before the election to cut rates, though I think that the economy will likely begin showing very real cracks by then.
The recent period of rising interest rates has presented a stiff challenge to my high-yield-focused investing strategy. That being said, I am thankful to have been able to identify just enough mispriced opportunities and score enough significant wins to be able to stay ahead of the market's performance.
Looking ahead, the storm clouds appear to be growing for the economy and it appears highly likely to me that the Federal Reserve will begin cutting rates at some point this summer. Time will tell, but between the suppressed valuations in many high-yield sectors, the aggressive recent buying from prominent investors in these sectors, the still greater than 50% chance of rate cuts this summer, and the defensive bent of the high-yield stocks in my portfolio such as Enterprise Products Partners (EPD), W. P. Carey (WPC), and Brookfield Renewable Partners (BEP)(BEPC) leave me feeling pretty confident in my odds of sustaining my outperformance of the broader market moving forward.