Two Income Stocks To Fight The Fed Hike

Nick Lanyi's picture

Friday, November 27, 2015 - 7:30am

by Nick Lanyi

It's been the worst of times for savers.

For more than seven years now, short-term Treasury notes -- and their close relatives, money market funds -- have delivered close to zero yield. This unprecedented period has meant the most conservative investors have had little or no income from their excess cash.

Is the money market drought about to end? I say, don't hold your breath.

Some observers have high hopes, based on the Federal Reserve Board's clear intent to raise the short-term rates it controls in the near future -- probably as soon as December. These rates directly impact short-term bond rates and money-market funds, as well as the interest rates banks pay depositors savings and checking accounts.

The good news is the Fed's imminent rate-hike policy will boost yields for money market funds and depositors. The bad news: it won't help much.

In my view, it's extremely unlikely that the Fed will raise short-term rates more than 75 basis points (0.75 percentage points) over the next 12 months. Long story short, the U.S. economy isn't growing fast enough to warrant an aggressive series of rate hikes, and with China's economic growth slowing and a presidential election coming up, the Fed will exercise caution.

Two or three rate hikes to stave off inflation? Probable. Two or three percentage points' worth? No way.

So, if you're looking for sources of income in 2016, don't count on the Fed to bail you out. Keeping some of your portfolio in cash-like instruments like money market funds or a bank account makes sense for a rainy-day fund. But the best source of income will remain higher-yielding fixed-income vehicles like corporate bonds, municipal bonds, real estate investment trusts and dividend-paying stocks.

Here are a pair of the latter to consider buying now to boost your income next year:

Verizon Communications (NYSE: VZ) is both the largest U.S. wireless services provider and one of the largest telephone, cable TV and Internet service providers. The company has 111 million wireless subscribers, 6.9 million Internet service customers and 5.8 million cable TV subscribers.

Long considered one of the best-managed telecom companies in the industry, Verizon generates prodigious operating cash flow and has invested smartly in a national wireless and wireline network, as well as strategic investments such as AOL, which contributes content and advertising revenue.

That said, Verizon operates in highly competitive sectors that face challenges from new technologies. Cable TV, for example, is threatened by the rapid adoption of streaming-video alternatives such as Amazon's (Nasdaq: AMZN) Prime streaming service and Netflix (Nasdaq: NFLX) and younger consumers' preference for mobile platforms rather than traditional TV. Unlike some of its competitors, however, Verizon has exposure to both wireless and cable and data services, so it should be able to capture growth wherever consumers go for video and data.

For income investors, Verizon's main appeal is its high dividend yield, currently close to 5.0%, which reflects regular annual dividend increases since 2007. Verizon's broad base of subscribers generates strong cash flow that covers debt service, acquisitions and capital expenditures in its networks while leaving free cash left over for share buybacks and dividend hikes. I wouldn't look for tremendous capital gains from this stock, but as a solid income investment it's hard to beat.

Southern Company (NYSE: SO), which I recommended in September, will soon be the nation's second-largest utility company. Its regulated electric utility operations are centered in Georgia, Alabama, Mississippi and Florida. It also has a variety of telecom operations and operates three nuclear power plants.

And as I wrote in September, Southern is acquiring AGL Resources (NYSE: GAS), an Atlanta-based natural gas utility with 4.5 million customers along the East Coast. The deal will help shift Southern from reliance on coal-fired power plants toward affordable, abundant and relatively clean natural gas and provides a steady source of that fuel for its own generators. 

Southern Company stock currently yields a hefty 4.8%; it has boosted its dividend every year since 2003 and has financial strength to continue to raise the payout for the foreseeable future. While Southern has been hampered of late by fears of rising interest rates, the current valuation discounts the two or three Fed hikes that most analysts anticipate.

Note that these are just two of the many attractive income stocks worth considering now. For one of the best sources of income recommendations anywhere, look to my colleague Amy Calistri, who excels at uncovering top notch income stocks in her premium newsletter, The Daily Paycheck.

Amy's Dividend Trifecta strategy of identifying dividend payers helps her maximize the income potential of her model portfolio. So far, she's collected over $92,000 in dividends over just five years, with stocks that yield as much as 13.3%.

Risks To Consider: These high-yielding stocks could suffer from faster-than-expected interest-rate increases, which make alternative income investments more appealing. And because they're in heavily regulated industries, both are subject to downside risk from negative regulatory rulings.
    
Action To Take: Buy Southern Company below $47 and Verizon Communications below $46.50.

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Nick Lanyi does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.