Lower Rates Lead to Mixed Impact on High-Dividend Stocks

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Surprisingly to Northlake, intermediate and long-term interest rates have fallen slightly over the last several months.  We had been anticipating higher rates as the economy emerged from COVID impacts, inflation held at well-above pre-pandemic levels, the timing of the Federal Reserve’s monetary policy tightening grew closer.  Instead, for reasons that most on Wall Street still do not understand, rates have fallen slightly.  Northlake still expects higher intermeidate to long-term interest rates over the coming quarters along with a partial re-steepening of the yield curve.

If we had to point to one reason for the recent dip in interest rates, it would be a quicker than anticipated fall in economic data and activity from peak post-COVID growth rates.  Given the virtual complete shutdown of the economy in 2Q20 and 3Q20, peak growth due to easy comps was always set to occur this summer.  Concerns about the impact of a pullback in stimulus and the possibility that spending had been pulled forward have been a steady source of debate.  The delta variant added another wrinkle as real-time data like OpenTable reservations and air travel appear to show a reaction.  The bond market seemed to anticipate weaker data which coupled with technical trading factors led to the surprising drop in interest rates.

Falling rates due to economic concerns did not hurt the overall stock market but investors rotated away from small and mid cap stocks, value stocks, and stocks of companies sensitive to the reopening of the economy.  Bond investors cheered, however.  Returns on major bond indices like the Barclays Aggregate have been positive for the past four months and bonds overall have about recouped the losses from 1Q21.  Year-to-date, bonds have produced no return.  Lower rates have helped Northlake’s preferred stock investments in Qurate Retail (QRTEP) and Liberty Broadband (LBDRP) since preferred stocks share very similar characteristics to bonds despite having “stocks” attached to their name.

The impact of interest rates on high-yielding stocks is normally quite straightforward.  Lower rates make the high dividends more valuable, while the opposite is true when rates rise.  Over the past few months, the relationships have not held.  Many high-dividend stocks are considered value stocks, including many that are also sensitive to the economic reopening.  Thus, stocks that Northlake favors with high dividends such as VICI Properties (VICI) or the iShares Select Dividend ETF (DVY) have slipped slightly off their highs since they have been lumped into the rotation trade that strongly favored growth stocks.  Verizon Communications (VZ) has also slipped from its spring highs.  Our best performing dividend stock has been Lamar Advertising (LAMR).  LAMR sits very near its all-time high as strength in advertising across all media has led to exceptional financial results and higher forward estimates.

We added AT&T (T) to client portfolios in late July.  AT&T is a total return play.  The dividend yield is presently 7% and we think the stock is undervalued based on operating fundamentals as management has aggressively shifted strategy to focus on the core communication services.  AT&T shares are sensitive to trends impacting high-dividend stocks.

There was big news at VICI a few weeks ago.  The company announced a takeover of peer casino gaming REIT MGM Properties.  We think this is a great transaction for VICI shareholders.  It is accretive to earnings which means the dividend should be going up faster than expected.  In addition, VICI shares are likely to be added to many REIT-focused funds due to the massive scale of the newly enlarged company.

AGG, LBRDP, QRTEP, VICI, LAMR, T, VZ, and DVY are held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.

Income Equity and Bond Quarterly Review

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Interest rates on bonds maturing more than a year in the future have risen since our last update on income equities.  At the end of November, the 10-year US Treasury bond yield was a little less than 1.00%.  Today, the yield is about 1.45%.  Short-term interest rates that are fully controlled by the Federal Reserve have not changed and remain close to 0.00%.  This means that the yield curve has steepened.  Intermediate and long-term rates have risen in anticipation of improving GDP growth resuming strongly with pent up demand driving growth well above the trend of the last few years prior to the pandemic.  Also contributing to a steeper yield curve is an increase in inflation expectations related to the anticipated surge in economic growth.  The Fed has not changed its market and economy friendly policies, continuing with extremely easy monetary policy.  There is concern among investors, however, that the Fed will beginning “tapering” or pulling back on its accommodations sooner than expected.

Rising interest rates are never good for bond returns and so far this year, the Barclays U.S. Aggregate index (AGG) has a total return of -2.2%.  AGG is similar to the S&P 500 in that it is a widely accepted benchmark.  Municipal bonds and high yield bonds have held up a little better, each down less than 1% this year, as these sectors of the bond market are most sensitive to the outlook for economic growth.

Against a backdrop of rising intermediate and long-term interest rates, Northlake’s income equities have performed fairly well.  The preferred stocks of Liberty Broadband (LBRDP) and Qurate Retail (QRTEP) are down slightly in 2021.  This would be expected as preferred stocks are most equivalent to regular bonds.  The slightly lower prices have no impact on the well above market current yields that attracted us to these securities in the first place.  LBRDP pays a dividend that supports an 8% current yield.  QRTEP produces a dividend yield of over 6%.  We remain highly confident in the credit quality of both of these securities.

Lamar Advertising (LAMR) and VICI Properties (VICI) are both up so far this year, helped by the rise in the stock market, rotation toward economic reopening stocks, and excellent earnings reports.  LAMR operates billboards in mostly second-tier cities and benefits as mobility improves and people get back in their cars.  VICI owns casino properties and is paid rent by operators like Caesars Entertainment.  Regional casinos have recovered well from COVID, while Las Vegas is improving but lagging.  Importantly, the credit quality of VICI’s tenants is getting support from quickly developing sports betting and online gaming for slots and table games.

Verizon (VZ) is down so far this year due to heavy spending for spectrum to support its 5G rollout and a very competitive mobile communications environment as consumers are enticed to upgrade to new 5G enabled phones.  The latest major spectrum auction was just completed and VZ has plugged the hole in its spectrum and improved its competitive position.

Finally, the iShares Select Dividend ETF (DVY) has done quite well this year as its holdings are mostly companies benefiting from the rotation trade.  The DVY portfolio contains many cyclical and value stocks including heavy exposure to financial and energy stocks.  All of these themes have been leading the market in 2021.

Northlake expects the yield curve to steepen further later this year with the 10-year U.S. Treasury yield moving towards 2.00%.  This will put pressure on bond returns, but income equities should still be able to produce positive total returns from current levels as the economy reopens.  We continue to look for income ideas to add to client portfolios including adding current holdings outlined in this blog post to more client portfolios.

AGG, LBRDP, QRTEP, VICI, LAMR, VZ, and DVY are held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.

Explaining Income Equities

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Beginning this quarter, we are adding a new blog post to cover the income-oriented stock and ETF ideas we have been increasingly using in client portfolios.  Not all clients use these investments, but we have broadened their use, so we thought it would be useful to produce summary commentary each quarter.

Up until 2020, most of the high-dividend paying stocks and equity ETFs had been purchased as bond substitutes.  Even prior to COVID, interest rates were at historically low levels that we found unattractive for long-term investment.  Northlake used stocks like Verizon (VZ), MGM Growth Properties (MGP), and Lamar Advertising (LAMR), and ETFs such as iShares Select Dividend (DVY).  These stocks and others served clients very well for many years.

Post the market collapse in March due to COVID, interest rates on money market funds have remained near 0% and the Ten Year US Treasury bond yield fell well below 1%.  Northlake made the decision to invest conservatively in 2020 due to the unusual risk surrounding COVID and the election.  We sold a lot of securities, and when we decided to begin reinvesting we saw high-dividend paying stocks and ETFs as a conservative alternative given our continuing concerns about the market.

Aside from credit quality, the primary risk for these investments is a sharp rise in interest rates.  Given the Federal Reserve and other global central banks clear guidance that they will keep interest rates low until the economy has moved well beyond the pandemic, we see little risk of significantly higher interest rates in the next few years.  A spike in inflation caused by excess monetary and fiscal stimulus could push rates higher, but we feel disinflationary trends from technology and the maturity of the U.S., Japan, and European economies makes sustained higher inflation unlikely.

Since the March stock market low, we have added to client holdings in DVY and Verizon and continue to own Lamar Advertising.  We substituted VICI Properties (VICI) for MGP and other high-dividend payers that we sold in March.  VICI was also added for a broader group of clients.  We also added two preferred stocks to our high-dividend portfolio, GCI Liberty (GLIBP) and Qurate Retail (QRTEP).  Each of these preferred stocks is part of Liberty Media, which we know well and have followed closely for 30 years.

VICI is a real estate investment trust closely tied to Caesars Entertainment.  The company acts as Caesars financing arm when real estate is sold but Caesars continue to manage and operate the property.  For example, VICI owns Caesars Palace, and Caesars Entertainment pays VICI under a long-term lease for the right to operate and manage the property.  VICI owns around 30 different casino gaming properties around the country.  Most are operated by Caesars Entertainment, but several other casino operators also have leases with VICI. There are two key aspects to our investment thesis on VICI.  First, despite the COVID lockdowns last spring, VICI received 100% of the rent payments it was due across its entire portfolio.  This speaks to the quality of the company’s cash flow used to pay dividends.  If COVID could not hurt VICI, it is hard to see a scenario that would impact the dividend.  Second, there remain many quality gaming properties throughout the United States still owned by the operators.  VICI has more opportunities with Caesars and we expect continued diversification to other operators.  VICI shares yield 5% and we think the company can sustain mid-single digit growth in dividends through rent escalators and more property acquisitions.  Northlake expects an attractive total return of 10% annually in a low interest rate environment with many unusual economic and market risks.

GLIBP and QRTEP are more like bonds given the fixed nature of their payments and maturity dates.  We see both stocks as a way for client accounts with a need for conservative investments to earn current yields well above money market and bond interest rates.

GLIBP is tied closely to Liberty Broadband (LDRDA) and Charter Communications (CHTR).  The primary support for GLIBP’s dividend payment is the GCI Liberty and LBRDA ownership of Charter Communications ownership of about 30% of CHTR.  CHTR is the second largest cable broadband company in the US and produces growing and stable free cash flow.  GLIBP pays an annual dividend of $1.75 for a current dividend yield of 6%.  The preferred matures in 2038.  Shares were purchased around $25 and now trade at $28.

QRTEP pays an $8.00 annual dividend which equates to a current yield over 8%.  The preferred matures in 2031.  Qurate Retail owns and operates QVC, HSN, and Zulily.  QVC and HSN have morphed from pure home shopping TV networks to ecommerce retailers with over half of current business done online.  We believe the 8% yield outweighs the risk of competition from Amazon and other ecommerce giants.  Qurate is growing, and the business produces very high free cash flow to support the QRTEP dividend.  Shares were purchased in the low-to-mid $90s and now trade at $99.

GLIBP, QRTEP, VICI, LAMR, VZ, and DVY are held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.