It wasn’t surprising to read in the FOMC minutes that the Federal Reserve is in no hurry to increase the federal funds rate. The prices of almost every commodity from crude oil and refined energy products to iron ore and copper have fallen sharply in recent months, and the strengthening of the US dollar has only accelerated the declines of dollar-denominated commodities for US-centric operators.
While we remain encouraged by the ongoing recovery in the construction and housing markets, pockets of weakness remain, and housing prices have yet to fully recover to pre-crisis levels in many parts of the country. Food prices are dropping, too – can you believe that 10 chicken nuggets at Burger King (QSR) cost a measly $1.49? There are value menus everywhere, from Yum! Brands’ (YUM) Taco Bell to Wendy’s (WEN) and beyond. Seniors can get a coffee at my local McDonald’s (MCD) for $0.63. A family of four can fill up on a $5 pizza from Little Caesars.
With reality as it is, how in the world can the Fed make any reasonable argument about inflationary risks? If the Fed may be creating any inflation through its lax monetary policies, from my perspective, it is creating real personal wealth, as in the example of rising stock prices. Investors are simply “getting rich” and their purchasing power is receiving an added boost as living costs all around them fall or hold steady. There is simply no need for credit tightening just yet. Everything seems to be working wonderfully. Employment is even at “full” levels.
Can you imagine if the Fed raises rates, and the equity markets collapse as a result? Ms. Yellen is not going to create problems that don’t exist. The Fed is well-schooled in Depression economics, and given what we know about current prices and employment, any premature credit tightening after arguably the worst economic environment in the post-WWII era is just not going to happen, at least not anytime soon. The Fed would rather be too late than too early. Even moderately elevated inflation is a much better proposition than the downward economic spiral of a deflationary crisis.
Much of the REIT industry popped on the dovish news, including newsletter positions HCP (HCP) and Realty Income (O). The latter is also coming off a nice fourth-quarter report February 16 that showcased revenue and funds-from-operations growth in the mid-teens relative to last year’s marks. Same-store rents at the self-proclaimed Monthly Dividend Company jumped 1.7% in the last quarter of 2014, and the REIT ended the year with portfolio occupancy at 98.4%, up 20 basis points on a year-over-year basis. Realty Income increased its annualized dividend per share 3% last month, to $2.268; that’s good for a forward yield of 4.3%. We value Realty Income’s shares at $60 each, revealing prospects for both capital appreciation and well-documented dividend growth.
In other news, the Dividend Cushion ratio struck again! This time it highlighted the risk of Transocean’s (RIG) dividend before it slashed its payout 80% on February 16. The company’s CEO also resigned, and frankly, we’re not seeing the investment case in shares at the moment, especially given the significant uncertainties that remain. This is the third instance so far in a young 2015 that the Dividend Cushion ratio warned of a dividend cut that was realized. Last month, the Dividend Cushion ratio revealed the significant risks related to Peabody (BTU) and Cliffs Natural (CLF), and both slashed their payouts, much to the dismay of income investors.
If you are not yet familiar with the Dividend Cushion ratio, please be sure to read up on the topic. I haven’t seen anything that comes close to its predictive value in assessing the financial risks related to a company’s dividend.