In case you missed it, let me sum up markets for you so far in October. Yields are rising. Stocks are falling. Tech stocks are getting killed. Defensive stocks are moving back in favor. The Federal Reserve is still thinking about hiking interest rates, but inflation has cooled. There hasn’t been any material progress made on the trade war front. And, ultimately, investors aren’t really sure what is next in this wild market narrative.
I think stocks bounce back from this selloff. This doesn’t feel like the “big one,” and most signs suggest valuations aren’t overextended and growth remains healthy. But, with rates rising, the market should also get more comfortable with bigger and more frequent bouts of volatility. As such, growth stocks may not do as well as they have in the past, and defensive stocks should do better than they have in the past.
Specifically, defensive stocks with big yields should do well. The defensive part of these stocks means that they should be resilient to potential broad economic and market weakness. Meanwhile, the big yield part implies that rising rates won’t inflict much damage.
Overall, now seems like a pretty good time to add some protection to your portfolio through defensive stocks with big yields. With that in mind, let’s take a look at three big-yield defensive stocks that should hold up well over the next several months.
The bull thesis on AT&T (NYSE:T) is pretty simple. This is a telecom giant that provides the most essential utility in the known world today outside of food and water: the internet. AT&T also provides wireless service coverage and cable connectivity. Demand for internet and wireless services will not waver, regardless of economic backdrop or rising rates, because they are essential and have no substitute. Demand for cable connectivity has been dropping and will continue to drop. But, AT&T is offsetting those drops with growth in its streaming business, so net drops in video subs is moderating.
Beyond its operational stability, AT&T also has a 6%-plus dividend yield. That is considerably higher than the 10-Year Treasury yield of 3.2%. Thus, you won’t get many investors ditching AT&T stock for Treasuries any time soon.
The one big concern with AT&T stock is the debt load. This company has an unprecedented amount of debt ever since the Time Warner acquisition. Rising interest rates on a huge debt load could burden the company and dilute profit growth. But, profit growth might get a lift over the next several years as streaming tailwinds offset cord-cutting headwinds, and that lift will likely cancel out the drag from higher rates. Overall, earnings growth should remain normal.
Normal earnings growth with a 6% yield and a defensive business model makes AT&T stock a strong defensive pick at current levels.
American Electric Power (AEP)
Utility stocks have long been viewed as bond substitutes. As such, utility stocks might not do so well as rates and bond yields rise. But, one utility stock that could buck the trend is American Electric Power (NYSE:AEP).
Considered one of the industry’s heavyweights, American Electric is a massive electric utility company that delivers electricity to more than 5 million customers across eleven states. As a utility company, demand is always stable. But, the business right now is doing especially well. Hotter than normal weather so far in 2018 has buoyed operations for the past several months, and robust economic strength in the company’s core markets has also boosted the business. Overall, sales and earnings are both trending higher at a healthy rate.
Because of this earnings growth, AEP’s total return is much higher than its stated 3.5% dividend yield. Long term earnings growth for this company is pegged at roughly 5%. The P/E multiple is slightly extended relative to historical levels, but not by much. Thus, total return for this stock over the next several years should come out to about 8%.
That is pretty good return for a low-risk stock like AEP. As such, AEP stock is strong defensive pick in a volatile market.
The two big fears out there are that rising rates will pressure equity valuations, and Fed tightening will kill economic growth. Neither of those risks should really affect Kroger (NYSE:KR) stock all that much.
Kroger stock has already been beaten up on Amazon (NASDAQ:AMZN) competition concerns. The stock trades at just 12X forward earnings, versus a five-year average forward multiple of 15. Meanwhile, the dividend yield is at 2%, versus a five-year average yield of below 1.5%. With such a beaten up valuation, it will be a while before rising yields cut into KR’s valuation.
Many would argue that the low multiple and big yield are the result of slowing growth. But, Kroger’s numbers have actually been pretty good, still are pretty good, and project to remain pretty good regardless of higher rates. Despite rising competition, Kroger’s identical supermarket sales ex fuel have grown at a pretty consistent ~1% rate over the past two years. Growth has persisted this year, with identical sales ex fuel up nearly 2% year-to-date. Moreover, regardless of rising rates, consumers still need to shop at grocery stores, so Kroger should be able to maintain positive identical sales growth for the foreseeable future.
Overall, Kroger is a defensive stock with a really low valuation, a bigger-than-normal dividend yield, and stable earnings growth prospects. Put all three of those together, and it’s easy to see that Kroger stock is good pick-up here and now to offset broader market volatility.
As of this writing, Luke Lango was long T, KR and AMZN.