Co-produced by Austin Rogers for High Yield Landlord
Warning: Recession Risk Is Increasing
It’s hard to believe, but many economists and market commentators are already talking about the next recession, just two years after the last one.
Typically, economic cycles last 5-10 years, but in the last few years everything in the economy seems to be moving at warp speed. Consider that since the beginning of 2020, the US economy has experienced:
- The worst pandemic in a century
- The lowest unemployment rate since the late 1960s
- The highest unemployment rate since the Great Depression
- Widespread deflation in the early months of COVID lockdowns
- The highest rates of inflation in 40 years
- The worst widespread shortages in decades
- The most geopolitical turmoil in decades
- One of the fastest stock market (SPY) meltdowns ever recorded
- One of the fastest stock market rebounds ever recorded
- The highest government debt levels ever, including during World War II
- The largest Federal Reserve balance sheet ever seen
- The lowest interest rates ever recorded in US history
The age of peace and stability seems to be gone, at least for now. And with the economy so rapidly vacillating between extremes, is it really that much of a surprise that we may now be headed once again for a recession?
Consider this: The trillions of dollars of stimulus money that the US government poured into the economy in 2020 and 2021, which resulted in massive spikes in personal savings, has now been utterly depleted.
In fact, Americans’ collective savings are now lower than they were before COVID-19 began. The economic boost from stimulus money is completely gone.
Moreover, though employers were forced to increase wages faster than the rate of inflation over the last few years because of an extreme labor shortage, that appears to be changing. In January, real personal income declined significantly year-over-year.
US Real Personal Income YoY:
Although it must be noted that this negative reading in January is also partly due to comparisons against a stimulus check month in the prior year.
What’s more, the additional unemployment income many were receiving is now gone. Though the flipside of that is that many Americans have been going back to work. The unemployment rate is back near its pre-COVID lows.
According to Federal Reserve Chairman Jay Powell, however, this unemployment rate is too low, signaling an unhealthy labor market and an overheated economy.
Indeed, when looking at the total labor force, we find that the number of Americans at work is now sitting roughly where it was immediately prior to the onset of COVID-19.
Obviously, more people working is generally better. But Fed officials have determined that it is necessary to blunt consumer demand and cool down the economy in order to fight inflation, even if that means tamping down on employment growth as well.
This demonstrates the very tricky position the Fed is in right now. They are stuck between a rock and a hard place: high inflation on one side and a fragile economy (exemplified by falling real income) on the other.
The Fed believes the bigger problem is inflation. Prices have simply risen too much too quickly. Inflation has become highly damaging to the US as well as the global economy.
Consider oil prices, which recently reached as high as $ 130 before pulling back. Such a rapid run-up in oil prices – well over 50% above trend – almost always signals an impending recession.
But the energy market was not the only one to be disrupted by the Russia-Ukraine war. The two countries are the “breadbasket of Europe,” together making up a significant share of global wheat, barley, and sunflower oil exports.
Planting season is approaching for these row crops. How badly will the world economy suffer if Ukraine misses an entire year of grains production? How much will inflation rise for the various foods and consumer goods that use these ingredients?
These concerns and others are why the bond markets have rapidly begun to price in an economic decline. Unless yields on the longer end of the Treasury yield curve rise significantly this year, yields on the shorter end of the curve are likely to overtake them.
If the Fed raises its benchmark rate by its planned seven times this year, the 10-2 year Treasury yield spread will most likely invert, which has historically been a reliable indicator of recession in the next 6-12 months.
At the current rate, the yield curve will invert within the next several months.
In short, despite the recency of the last recession, the odds of another recession beginning in the next year or so are rising. For investors, the question is “should we remain invested” but rather “how do we prepare for a potential recession?”
With that in mind, let’s take a look at two high-yield stocks that should perform well going forward whether the economy dips into recession or not.
1. Medical Properties Trust (MPW)
MPW is a real estate investment trust (“REIT”) (VNQ) and the 2nd largest non-governmental owner of real estate hospital in the world with over $ 21 billion of total assets. Though spread across four continents, MPW’s properties are mostly concentrated in the US and European NATO countries:
A little over 3 / 4ths of MPW’s revenue derives from hospitals, but the REIT also receives 10% of its rent from behavioral health facilities and another 10% from inpatient rehab centers.
Despite the high costs of healthcare, hospital operators (MPW’s tenants) typically do not enjoy high profit margins. This causes the property type to trade at relatively high cap rates in the high single-digits.
Fortunately, despite low margins, MPW’s tenants do boast relatively strong rent coverage ratios in excess of 3x as well as frequent ad hoc government support during times of economy-wide distress. During COVID-19, for instance, many hospital operators received financial assistance from the Department of Health & Human Services.
Moreover, since MPW acquires properties in direct sale-leaseback transactions with tenant-operators, the REIT is able to secure several landlord-friendly lease terms, such as net leases (no landlord responsibility for property maintenance, insurance, or taxes), long lease terms, CPI-based rent escalations, and master leases covering multiple properties under one lease.
Around 90% of MPW’s leases have CPI-based escalators, with ~ 75% of those including a ceiling of 4.5% annually. Around 9% of MPW’s leases have fixed rent bumps averaging 2.3% per year. In short, MPW is better protected from inflation than the vast majority of long-let real estate.
The REIT sports an investment-grade credit rating (BBB- / Ba1), with reasonable debt levels given the relative stability of its properties. MPW ended 2021 with a pro forma net debt to EBITDA of 6.4x. While still on the high side, that is actually down from the higher levels the REIT’s net leverage ratio has been at in previous years.
Despite having a barely investment-grade credit rating, management has done a good job of arranging low-cost financing. The weighted average interest rate on debt at the end of 2021 sat at 3.1%.
The primary reason MPW’s stock price has dropped recently, despite strong results, is a hit piece published in the Wall Street Journal that cites old data on hospital tenants’ COVID-era losses and portrays private equity’s entire presence in the hospital space as shady.
But hospitals have performed much better coming out of the pandemic, and while MPW benefits from private equity’s role in healthcare by generating more sale-leaseback deals, the REIT plays no part in hospital operations. It is simply a landlord.
Certainly, none of these criticisms seem to have affected MPW’s performance. For the full year of 2021, AFFO per share rose over 13% to $ 1.37 from 2020’s $ 1.21, and the dividend was recently raised by 4%.
Between a nearly 6% dividend yield, 6-8% annual cash flow growth, and valuation upside, MPW currently offers potential total returns of 15-20%. That’s very attractive coming from a recession-resistant business.
2. Williams Companies (WMB)
WMB is one of the largest natural gas-focused midstream energy companies in the United States, carrying approximately 30% of the nation’s gas through its infrastructure network of pipelines and storage facilities. An especially critical piece of both WMB’s portfolio and the nation’s energy infrastructure is the Transcontinental Pipeline, which stretches from Texas all the way up the Eastern seaboard to New York.
As European nations turn away from Russian gas and begin receiving more LNG imports from the United States, the Transco Pipeline’s value rises significantly, as it connects the Marcellus shale gas in the Mid-Atlantic region to LNG export facilities in the Gulf of Mexico. Global LNG demand is projected to double over the next 20 years.
As you can see above, Transco also intersects many of the most densely populated regions of the country. There are plenty of possibilities for pipeline expansions to connect Transco to new gas-fired power plants being opened to replace coal power plants.
WMB is also well aware of developed nations’ desire to decarbonize their energy provisions and is actively advocating a role for natural gas to play in that process. Natural gas burns cleaner than either coal or oil, and management sees it continuing to take market share in electricity generation from those two energy sources.
Though renewables are more exciting to many investors today, natural gas will undoubtedly have a big role to play in energy provision for decades to come. Until battery storage technology has markedly improved from its current state, gas will be necessary to provide a reliable power source to supplement the intermittency of renewables.
In recent years, like other blue-chip midstream companies, WMB has slowed dividend growth and transitioned to a more self-funding model while deleveraging. These efforts have resulted in dramatic improvement to the balance sheet, increased dividend coverage, and consistently growing EPS.
As another positive, WMB is structured as a corporation and generates a 1099 form rather than a K-1 form for tax purposes.
Between WMB’s 5.5% dividend yield and growth of 5-8% per year, WMB’s total returns should register in the double digits for years to come. The current crisis benefits the company and not the other way around.
Whether a recession is coming in the next year or so is unclear, but it would be hard to deny that a recession is becoming more likely. This news ought to give investors caution, but it should not cause investors to exit the market completely. Historically, more money has been lost trying to time market corrections than in the corrections themselves.
So, in today’s environment, we “proceed with caution,” to quote Howard Marks, by trying to find defensive stocks with high yields. MPW and WMB are two attractive options right now.