7 Stocks to Sell as the Fed Hike Hits Stocks

As the Fed rattles investor confidence, these seven stocks are at high risk

stocks to sell

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The Federal Reserve’s rate hike on Wednesday wasn’t a surprise at first blush — it was in line with the market’s expectations. However, Fed Chairman Jerome Powell did throw the market for a loop with the removal of the word “accommodative” from the Fed’s policy outlook.

It’s no secret that the Fed has helped bolster stock prices with its easy monetary policy in recent years. As the Fed tries to return to normalcy, this huge tailwind that has helped power up the great bull market will go away. As we saw Wednesday, any drop in support from the Fed can hit the market hard; stocks turned on a dime following the Fed news release and suffered intense selling in the final hour of the day.

That brings us to an important question. What stocks are in the most danger as the Fed demonstrates its increasingly hawkish outlook for interest rates?

Ford (F)

Stock To Sell: Ford (F)
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Ford (NYSE:F) is trading near its 52-week lows, having recently fallen below the $10 level. This probably won’t be the bottom for the firm, however.

Ford faces several issues relating to higher interest rates. For one, the auto market relies heavily on consumer finance. In fact, car companies arguably make more money in aggregate from financing consumers’ purchases than in actually manufacturing the cars themselves. However, it gets more difficult for automakers to offer attractive financing packages as interest rates keep rising.

On top of that, the auto market appears to have already topped. It’s a highly cyclical business. And with auto sales having been so strong in 2015 and 2016, it’s hard for the industry to keep up its momentum. Most consumers don’t buy new vehicles every year or two, so with so many recent purchases, much potential demand has already been used up. Throw in Ford’s substantial borrowing needs in a capital intensive business, and higher interest rates are a major headache for the company.

General Mills (GIS)

General Mills (GIS)
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Don’t expect things to get any better for General Mills (NYSE:GIS) anytime soon. GIS stock took another tumble recently following another downbeat earnings report. Its recent declines extended its year-to-date losses to 27%.

The problem is simple. In its core North America market, sales volumes continue their multiyear decline. Cereal sales appear to have peaked roughly a decade ago, and are in retreat now. General Mills is also big in yogurt, but they missed the Greek yogurt trend so that division has underperformed as well. The company recently made a big move, paying a princely sum of $8 billion for pet food maker Blue Buffalo. Investors reacted harshly, slashing billions off General Mills’ market value afterwards.

Unfortunately, General Mills has no easy path forward. They have a massive debtload, and their core products aren’t as popular with consumers as they used to be. The company’s main appeal to investors was its 4% dividend. But this dividend is in increasing jeopardy as the company’s balance sheet erodes. Higher interest rates on its outsized obligations will serve as a further hit.

Investors who own GIS stock for its dividend will increasingly look to safer alternatives that also pay 4%-plus in coming months, sending it to fresh lows.

Realty Income (O)

Realty Income (O)

It’s no secret that REITs tend to underperform during periods of rising interest rates. More than just about any other type of stock, people buy REITs for their dividend yields. Over the years, we’ve seen a tight correlation between treasury yields and the yields that REITs fetch on the stock market. As treasury yields continue to spike, it will drag up the yields required for REITs to attract investor capital as well.

Why sell Realty Income (NYSE:O) in particular? While the whole sector faces a headwind from higher interest rates, a triple net REIT like Realty Income has less insulation from rising rates. Other REIT sectors such as hotels, shopping centers and malls benefit from a stronger economy. And defensive ones, such as storage, may catch a bid as investors fret about a recession following the Fed’s aggressive rate-hiking campaign.

Triple net lease REITs such as Realty Income, with their long rental contracts on properties, have less protection. Rising inflation hurts them, since it takes longer for rents to move upward. Meanwhile, with higher interest rates, their profits will fall as interest costs on their debt rises. All in all, interest-rate-sensitive REITs tend to see their yields move on an equal basis with treasuries. Thus if the Fed hikes another three times this cycle in addition to Wednesday’s move, bringing interest rates up 1% in total, Realty Income’s yield should also rise 1%, from 4.6% now to 5.6%. To get there, the stock would have to drop almost 20% to $48 per share.

NextEra Energy (NEE)

NextEra Energy (NEE)
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You know it’s a frothy market out there when America’s leading utility by market cap trades at more than 20x earnings. Usually power generators trade in the low to mid teens on a price-to-earnings-ratio basis. But in this market, people are willing to pay up for anything with even a hint of growth. And yes, NextEra Energy (NYSE:NEE) has a more attractive growth profile than much of its competition.

But its $80 billion market cap could be in for quite a fall. Like with REITs, investors tend to buy utilities for their steady and predictable dividends. In the case of NEE stock, there’s simply not enough dividend here to justify owning it against other alternatives. At the present time, FDIC-insured 1-year Certificates of Deposit are available for rates as high as 2.65%. A 10-year U.S. treasury bond pays greater than 3%.

So what is the incentive to own NEE stock paying 2.7% as a yield investor? Sure, NextEra Energy could go up further. But most conservative yield investors aren’t picking stocks primarily for capital gains potential. And with more generous alternatives around, NextEra will look less and less attractive at its current price.

Reset NextEra to a 3.5% dividend yield — more in line with what you’d expect for a high quality utility stock in a low interest rate environment, and NEE stock is worth just $125 per share. That’d be a steep haircut from its current $165 price.

AT&T (T)

AT&T (T)
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Similarly, investors tend to buy telecoms such as AT&T (NYSE:T) and Verizon (NYSE:VZ) for their dividend yields. AT&T stock in particular has traded at around $35, give or take five bucks, since 2012.

AT&T has shown little ability to organically grow its business. That has led the company to take on increasingly aggressive acquisitions including Mexican cell phone operators, DirecTv and now Time Warner. Will these deals work, or is AT&T simply overpaying for large assets to try to give the appearance of strategic direction?

In any case, the main attraction here, given the company’s uncertain business plan and struggling core operations, is the dividend. That 5.9% dividend yield is certainly eye-catching. But with the company unable to grow either earnings or the dividend payout by much, investors may grow impatient with AT&T’s lack of progress. Given AT&T’s mammoth debtload, rising interest rates will also crimp the company’s bottom line over time. It exits the Time Warner merger with almost $200 billion in debt; thus, every 1% rise in the interest rate on their debt costs them nearly $2 billion per year.

Bank OZK (OZK)

Bank OZK (NASDAQ:OZK), until recently known as Bank of the Ozarks, has been one of the most impressive operating stories in finance over the past 20 years. A tiny regional bank appears to be beating the big boys at their own game. Twenty years ago, OZK stock was worth less than a dollar. As recently as 2008, OZK traded at $5. It’s at $40 now.

Unfortunately for OZK stockholders, the future is unlikely to be as good. The company has prospered by betting aggressively on risky construction loans in sagging markets where other national lenders have dared to tread. OZK, despite its Midwestern roots, for example, has a huge business in the struggling Miami real estate market.

Despite barely being one of the nation’s 100 largest banks, it is the No. 1 player in construction loans outpacing national leaders including Wells Fargo (NYSE:WFC) and Bank of America (NYSE:BAC). This is great on the way up, as construction loans tend to have high profitability and more limited competition. But with the Fed on an aggressive course, we should expect construction and land development loans to start going bad at an accelerated rate. This could leave OZK stock in a world of hurt.

Unlike most banks, OZK is not a particularly conservative operation and thus faces more risk from a slowing economy as interest rates impact construction efforts.

BBVA (BBVA)

BBVA (BBVA)
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Another impact of higher interest rates is that they tend to make U.S. dollar-based assets more attractive in comparison with alternatives. That’s especially true of emerging markets. When you can pick up safe yield in the United States, why take the risk of investing in a more exotic country for yield?

As such, emerging-markets stocks have been tumbling all year. The Fed’s aggressiveness has caused investors to flee risky markets, and shaky currencies have been getting slammed. The Turkish lira and Argentine peso, in particular, have been crushed, with both down close to 50% year-to-date.

That’s terrible news for Spanish banking giant BBVA (NYSE:BBVA). The $40 billion market cap banking empire, unfortunately, has major franchises in both Turkey and Argentina. It also operations in a number of other, healthier countries, such as Mexico and Colombia. Regardless, investors are bailing on the bank due to its high exposure to emerging markets at risk of total meltdown as the Fed’s rate hiking campaign accelerates.

There could be a good buy on BBVA stock as the Fed approaches the end of this rate hiking cycle. But for now, the recent 10% rebound in BBVA stock is a gift to sell into, as shares are likely to make new lows in coming months.

At the time of this writing, Ian Bezek had no positions in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2018/09/7-stocks-to-sell-as-the-fed-hike-hits-stocks/.

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