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Income Builder Model Portfolio

Monthly Portfolio Review: July 2024

Publication date: August 5, 2024

Current portfolio holdings

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Executive summary

• The Income Builder delivered a 6.3% total return in July, which substantially outpaced the S&P 500 Index, which returned 1.2%.

• Long-term interest rates fell sharply in July as inflation moderated and signs emerged of slowing growth (a trend which has continued into August in the wake of last week’s anemic jobs report).

• A number of Income Builder positions are long duration cash flow businesses that have benefited from falling rates; these stocks could continue to perform relatively well in a market environment that anticipates weakening growth.

• We continue our discussion of the potential impact of the Presidential election on energy-related stocks and provide more detail on specific portfolio positions.

Performance review

The Income Builder portfolio delivered a strong performance in July with a total return of 6.3%, substantially outperforming the S&P 500 Index, which delivered a total return of 1.2%. Individual position returns ranged from -5% for Permian Resources (PR) to 24% for Carlyle Group (CG).

As we highlighted last month, performance comparisons with broad market indices have become quite tricky recently given the now immense importance of a handful of mega-cap technology-related companies. With the Magnificent Seven representing over 30% of the market capitalization of the S&P 500, the index arguably provides a distorted picture of overall market performance when these stocks deviate from the rest of the market.

Whereas Mag 7 stocks drove returns in June, they were on average slightly negative performers in July, having retreated sharply from peaks reached earlier in the month. NVIDIA (NVDA) had a particularly volatile July. While only down approximately 5% in July, this is after shares of NVDA rose 13% on the last day of the month. Over the course of the month, shares of NVDA had a 23% peak to trough move to the downside before rallying on the final trading day.  

Given the recent leadership and outperformance of Mag 7, AI/tech and large-cap growth stocks generally, many market observers have applied the catchphrase “great rotation” to describe the market movement that has taken place, especially in the final weeks of July.

Over the course of the month, value stocks and small-cap shares significantly outperformed tech, growth and large-caps. This reflected a sense that the valuation gap had become too wide, especially since the Nasdaq 100 ETF (QQQ) peaked on July 10. Small cap stocks, as represented by the iShares Russell 2000 ETF (IWM), ended the month up 10%, while value stocks, as represented by the Vanguard Value ETF (VTV), were up 5%. This compares with a -2% performance for QQQ.

The great rotation narrative was visible as well in the relative performance of the different sectors within the S&P 500. Out of 11 sectors, there were 9 sectors that outperformed the overall index, in some cases producing substantially positive returns. Only the tech sector generated a negative return in July.

While the month of July saw investors move capital from previously high performing large cap tech stocks to other areas, in the very first days of August, we witnessed a pronounced shift in market sentiment and focus. A much weaker than expected jobs report brought down growth stocks and cyclicals. In case you missed it, we commented on this on 8/2/2024 in a 76report Quicktake, which is available here.

Portfolio highlights

Several stocks within the Income Builder portfolio contributed to the strong performance for the month, while only a handful of positions underperformed the broader market.

Performance was led by alternative asset managers Carlyle Group (CG), which advanced 24%, and Blackstone (BX), which gained 15%. We attribute the strong performance of these names to various factors including declining interest rates, which favor private equity investing; a strong earnings report from BX as the industry bellwether; and participation in the market rotation away from large cap tech.

Additionally, as we have previously noted with respect to CG, there has been some arguably unwarranted weakness in the shares in recent months, which has now reversed with the improvement in sentiment.

The sharp move in long-term interest rates during the month benefited a number of other portfolio holdings as well. The yield on the 10-year Treasury declined substantially in July in response to various signals of lower inflation and slowing growth. The 10-year yield fell from 4.37% at the end of June to 4.05% at the end of July.

It is worth noting that in just the first two trading days of August, the yield on the 10-year Treasury has fallen further to 3.80% in the wake of the weak jobs report.

Crown Castle (CCI), WEC Energy Group (WEC) and VICI Properties (VICI) advanced 13%, 10% and 9% respectively in July. Each of these stocks are characterized by long duration cash flow streams and are therefore natural beneficiaries of a falling rate environment.

To the extent the market is transitioning into an environment of slowing growth and looser monetary policy, we would expect CCI, WEC and VICI to outperform as more defensive, interest-rate sensitive stocks. The high interest rate environment of the past few years has led to substantially lower valuation metrics being applied to these particular stocks, relative to how they have historically traded. The outperformance this month comes in the context of significant underperformance, especially over the past two years.

The worst performer in the portfolio was Permian Resources (PR), which fell 5%. On July 29, PR acquired acreage from Occidental Petroleum (OXY) for approximately $800 million, in a deal financed with both debt and equity. The deal was well-received as the acquired assets fit directly within PR’s Delaware Basin portfolio and provide PR with unique operational synergies. Despite the favorable financial metrics on the deal, such as a 17% free cash flow yield, the equity placement has led to some short-term pressure on the shares.

We continue to view PR as an especially interesting oil and gas producer with a valuable resource base that is undervalued relative to larger peers. Management continues to grow the portfolio prudently with value-creating bolt-on acquisitions. At some point in the future, we would expect PR to be acquired at a premium by a larger player.

Spotlight on energy

In a recent 76report, we reviewed our expectations for how the outcome of the U.S. Presidential election could impact the energy sector. The key takeaways are that a Trump administration would likely lead to lower fossil fuel prices, especially oil, but would also de-risk fossil fuel investments and likely generate more investment in the sector. A Harris administration could produce higher oil prices and enact policies that direct more capital into renewable energy. That analysis is available below.

Energy Stocks and the Election

As a continuation of that discussion, we review in this context the holdings of the Income Builder portfolio that are either direct energy sector positions or closely linked to energy markets.

Permian Resources (PR) and Diamondback Energy (FANG)

As oil and gas producers operating in the Delaware Basin, PR and FANG are subject to similar economics. Higher oil and gas prices will improve their profitability. To the extent a Trump victory translates into somewhat lower oil prices, this could be a headwind. On balance, however, we believe investors will be more inclined to own these asset bases, which consist of long-term oil and gas reserves, if Trump is elected and policy shifts in the direction of traditional energy sources.

A Trump victory could also unleash the “animal spirits” within the fossil fuel sector and drive more aggressive M&A activity. This could benefit PR shareholders in particular.

Williams (WMB) and Kinder Morgan (KMI)

Both WMB and KMI own and operate key pieces of the U.S. natural gas infrastructure. Because of growing demand for electricity, growth limitations on intermittent renewable power sources like wind and solar, and hostility to coal and nuclear, natural gas is well-positioned for the long-term.

Harris’ policies could promote more Electric Vehicle (EV) use, which would potentially translate into even stronger electricity demand. On the other hand, Trump’s commitment to developing domestic oil and gas production, including Liquefied Natural Gas (LNG), would be quite favorable for WMB and KMI. Both companies stand to benefit from more volumes flowing through their existing infrastructure assets as well as high return investment opportunities related to new projects that are adjacent to their pipelines.

On balance, pipeline investors likely stand to benefit more from a Trump victory, but either way should benefit in the long-term from the electrification trend.

Key metrics

Valuation detail

Performance detail

Company snapshots

Blackstone (BX)

Crown Castle (CCI)

Digital Realty Trust (DLR)

Diamondback Energy (FANG)

Texas Instruments (TXN)

VICI Properties (VICI)

Williams (WMB)

Carlyle Group (CG)

Kinder Morgan (KMI)

Mid-America Apartment (MAA)

Permian Resources (PR)

Sempra (SRE)

WEC Energy Group (WEC)

The 76research Income Builder Model Portfolio is intended for income-oriented investors and managed to generate an overall yield that is materially higher than broad equity indices. The portfolio primarily includes stocks with above average dividend yields from a cross section of industries. While investments are screened for their income and income growth characteristics, specific holdings are chosen based on valuation and general business quality, growth and risk considerations.

Disclaimer

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