Burning a Hole in My Pocket

I’m talking about the cash I have sitting here that I desperately want to get into the market. Earlier this year, I got a chunk of money from selling a house. I have no desire to own another home (that’s a story for another time.) Instead, I used some of the money to pay off some debt. The rest is just sitting in my savings account earning absolutely nothing.

That’s a nightmare for someone that preaches the power of collecting an above average yield on your investments. Yield is how we measure the horsepower of our money using an annualized percentage so we can compare different types of opportunities. Right now, my money is akin to a car sitting up on bricks.

It’s not for lack of trying.

I’ve been running my stock screeners weekly… and some weeks daily. My watchlist keeps growing at an alarming rate, but I can always seem to poke holes in my argument. And if I find something I do like, the current price just seems too high.

The good news is that I think the time I’ve been waiting for is just around the corner.

The Trickle Through

Unless you’ve been living under a rock or in a glorious tech-free retreat, you probably know that the FOMC hiked the fed funds rate last week. They had been on a pause since late last year. Doubt was spreading that the Fed would step in to get us back to its 2% inflation goal.

Now the pendulum has swung in the other direction.

Chairman Warsh, of course, ignored specific questions about more hikes through the end of the year. But the dot plot shows us that the committee is eyeing at least one more, potentially two.

When rates go up, generally stocks should go down.

Higher borrowing costs mean businesses have to pay more to service their debt as much of it is floating with a floor. Even if their current rate remains unchanged, new debt will certainly be at a higher rate which can slow down expansion plans. Future valuations should be readjusted and discounted accordingly.

Then there’s also the fact that higher bond yields can coerce some people to pull their money from stocks and put it into bonds. Treasury ETFs and Fixed Income ETFs saw substantial inflows of about $9 billion last week… while US equity ETFs saw net outflows of about $1.1 billion.

So, only half of my expectations are coming true. Investors are looking towards bonds, but they are not exiting the stock market at the same rate. The S&P 500 is still chugging higher, almost back to its 52-week high. Our opportunity is coming, but not overnight.

Optimism Has to Shake Out

It’s not just companies that will be hit with higher borrowing rates. Consumers are already stretched thin by higher grocery prices and sky-high gasoline prices. Some people are already relying on plastic to fill the gap between paychecks. Variable rate credit cards are tied to the prime rate dictated by the fed funds rate.

But investors are not going to price in the higher borrowing costs for either group until it becomes tangible in earnings figures. That’s not going to happen in the third quarter which ends in just one week.

I would bet that every single management team is currently preparing their remarks on how the interest rate hike will affect their business. They know analysts will certainly ask about it in the earnings call. I don’t think it will matter at all what they say.

Investors have been so optimistic for the past seven or so earnings seasons that it really doesn’t matter. They latch onto the positive and sweep the challenges under the rug. That can only last for one more quarter. When the full-year earnings are released in January, they will have to pull their heads out of the sand. That’s when I think the return to rational valuations will begin.

Let me be clear: I’m not predicting a broad market crash. I am, however, saying that some of the air will be let out of the valuation balloon. And that’s the buying opportunity I’ve been waiting for.

But what should we do until then?

Action Steps Right Now

First, take a look at your gains. If you have big gains sitting on the table, it’s time to think about your exit strategy. I know this can be hard as a dividend investor. Your shares are up, but that wasn’t the original point of the investment. You have a great entry price for a great effective yield.

If you don’t want to sell right now, come up with your strategy. Maybe you pick a target price to sell. That might be a higher “goal” price. Or it could be a lower “protective price.” Maybe you will sell if shares drop a certain percentage in a week. Make a plan now before the optimism fades. It could happen sooner than I think.

Second, consider selling covered calls on your positions. Whenever I sell a covered call, I decide that it’s okay if I have to sell my shares on the expiration date. This can be part of your exit strategy on your larger gains as well.

This is a way to harness short-term volatility and unlock extra income.

Finally, add to your favorite undervalued positions sparingly.

Okay, I know I was just grumbling about nowhere to put some of the money from my recent payout. I have been putting a little of it to work in the markets, but nowhere near as much as I would like. I have sparingly added to some positions that the market is simply undervaluing right now.

I still like VICI Properties (VICI) in my REIT holdings. The experiential real estate giant has been expanding its portfolio, but casinos are still at its core. Ceasars Entertainment is its largest tenant, and it looks as though it will be taken private before the end of the year. Investors are worried about the uncertainty here.

I’m still bullish long-term. However, shares have dropped this year boosting VICI’s current yield to 7.7%. I’m steadily adding to my position.

Kimberly-Clark (KMB) is another position I’ve been adding to. Shares are down 21% over the past year, pushing its current yield to 5.2%. The company is in the latter stages of seeking regulatory approval for the acquisition of Kenvue Inc. (KVUE) to truly take over the real estate in your bathroom cabinets.

Or add to whatever your favorite undervalued position is in your portfolio right now. If it’s beaten down and you still like it long term, it’s a good candidate.   

For more income, now and in the future,

Kelly Green