AT&T, Twitter, and Investing for Peak Inflation

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And there are some green shoots, I think, pointing in the direction that we could be reaching a peak here.

Hello and welcome to the Barron's Streetwise Podcast. I'm Jack Howe. The voice you just heard, that's Lindsey Bell. She's the Chief Investment Strategist at Ally Invest, and when she mentions a peak, she's not talking about the stock market. She's talking about inflation. Just ahead, we'll get perspectives from Lindsey and another top strategist about what's next for consumer prices and interest rates and how best to invest. We'll also get a fund manager's top picks for dividend-paying stocks, and we'll say a few words about Elon Musk and his cannabis-themed takeover bid for Twitter. Listening in is our audio producer Jackson. Hi Jackson.

Hi Jack.

Who was it that sent us that question on AT&T?

Well, that was Mike from Colorado.

The Mike from Colorado. Let's hear it.

Hi, Jack. AT&T or Warner Bros. Discovery, which of these two stocks has more investment upside from a growth and dividend perspective in the next 12 to 24 months? Thanks so much.

Hey, Mike, thanks for listening and for sending your timely question. Anyone who owned AT&T stock earlier this month now has 2 stocks: AT&T, which still uses the ticker T, and something called Warner Bros. Discovery, ticker WBD. That's because the telecom has decided to leave Hollywood. Back in 2018, AT&T bought Time Warner, which had a movie studio and cable networks and HBO, and the thinking was that AT&T would take all of this entertainment direct to customers through streaming. If you asked me back then which was the more exciting business, Mike, I might have said that investors seem to care a lot about streaming and don't care that much about a slow-growing telecom with a big dividend. But times have changed. Streaming has gotten crowded. Netflix stock has been a terrible performer over the past year. Companies are spending heaps of cash on content In AT&T's case, that was money that couldn't be used to pay dividends or reduce debt or invest in its phone network. So AT&T decided to spin off WarnerMedia, and Discovery decided to buy it. Now investors are left with a pure-play telecom and a pure-play show business stock. And Mike, I have to tell you, I think big dividends are looking pretty tasty right now. B of A Securities just put out a research note predicting what they call a total return world. The bank's strategists predict that on price alone, the S&P 500 will average low single-digit returns or even negative returns over the next decade. Dividends, they say, will be paramount. They also point out that dividends have scarcity value because company payouts are low, and dividends offer income that can rise with inflation. And lately, dividend stocks have been outperforming I asked one dividend investor if he likes AT&T more or less after the Warner spinoff. He says he likes it more.

I would say what most people dislike about AT&T is they feel like it has an inferior network because money that could have been invested in the wireless and fiber businesses was invested into WarnerMedia.

That's Austin Graff at Titleist Asset Management, which is based in Texas and manages just over a billion dollars. Austin helps manage a fairly new and quite small exchange-traded fund called TrueShares Low Volatility Equity Income, ticker DIVZ. It's an actively managed fund, meaning Austin picks the stocks. Austin says that before the split, AT&T's core businesses generated a lot of cash, but that the company used that cash to invest in its less profitable businesses like streaming. In the hope that those would generate cash in the future.

And so I like a business that generates a lot of cash today and shares that cash with investors in the form of dividends and even buybacks, but primarily in dividends.

AT&T now yields 5.7%, which is almost suspiciously high, but Austin says the company will make plenty of money to invest in its network and pay down debt and increase its dividend payments. I asked him for some of his favorite dividend stocks. Now, he likes Philip Morris International, ticker PM, which yields 4.9%, and American Electric Power, AEP, which yields 3.1%, Johnson Johnson, JNJ, that's 2.3%, JP Morgan, JPM, that's 3.2%, and there's Devon Energy, DVN, which has a variable dividend payment and could reach a yield in the high single digits or even double digits over the next year. We've had Philip Morris and Devon on past episodes of this podcast. So Mike, you're asking which of your two stocks has the most total return potential over the next 12 to 24 months. I don't exactly know, of course, because predicting short-term stock returns is devilishly difficult. But in this environment, I'd probably feel more comfortable with the AT&T in that big and potentially rising dividend. Hopefully management can stay away from show business for a while. Okay, let's do the quickest of updates on Twitter. Last week we talked about how Elon Musk had taken a 9% stake and was stirring controversy. This past week he offered to buy the whole company at $54.20 a share. Why $54.20? Well, As I mentioned last week, he likes making 420 references, which are an inside joke among cannabis fans. And if you look at where Twitter was trading, $54.20 was the next price that included the number 420. I realize that's an unorthodox valuation system. Now, Elon's offer is a fortune compared with the $39 and change that Twitter was trading at before his stake was originally announced., and the stock has been a lousy performer since its first day of trading in 2013. But at one point last year, shares had shot above $70, so it would be awkward but by no means out of the question for Twitter to say that Elon's offer is too low. Twitter got support for that argument from a Saudi investment firm and major shareholder that tweeted that it would reject the offer. Elon indicated to Twitter that he had given his best and final offer and that he wouldn't remain a shareholder if it wasn't accepted. The stock ended Thursday around $45 a share, down slightly for the day, suggesting that investors don't think the deal will happen. So a few things could happen now. Twitter could accept the offer in its current form and shareholders could make around 20% from Thursday's close. The company could ask for a higher price and Elon or a competing investor could offer more, or the deal could fall apart and the stock could fall back to $39, which would be a 13% decline, or it could fall even more if investors come to believe that a takeover now looks out of the question. One last footnote: on Friday, Twitter adopted a poison pill. That's a defensive measure that limits the percentage of the company that Elon can buy and gives Twitter time to consider his offer. Next up, earnings season, inflation, and how investors should prepare. Jackson, is that a good enough tease? I feel like I'm not really selling it here.

Up next, you won't believe your ears.

Has inflation peaked or has Jack peaked?

That's not an either-or choice. That's all next after this quick break.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.

We call it earnings season because quarterly reports for big companies mostly arrive clumped together over a few weeks. This past week, the companies that reported represented only about 5% of the S&P 500 index's stock market value. But over the next 3 weeks, we'll hear from 15% of the index, then 48%, and then 16%. And by then, we'll know all we need to know about how companies are doing. But we can already make some early assumptions. First, going into earnings season, Wall Street was predicting 4.6% earnings growth for the first quarter. That's a big downshift from previous quarters, mostly because companies are no longer bouncing back from a very low base. A rising oil price has been great for energy profits. If you take those out, remaining S&P 500 earnings growth would be estimated at close to zero. Bank profits are expected to be hurt by them setting money aside to cover loan losses and upheaval from the war in Ukraine. That's more or less what JPMorgan's results showed this past week. If you take out banks but you leave in energy, S&P 500 earnings would be projected to rise 14% for the first quarter. 3 more things to know about earnings. Revenue growth for the quarter is expected to be excellent. Over 10%. It's highly unusual for revenue to grow that quickly while earnings growth lags behind. It means profit margins are contracting. One thing that could cause that is if the revenue growth is being driven by inflation and companies are scrambling to keep up, and that's just what's happening. Also, keep in mind that companies tend to manage earnings expectations lower and then beat estimates more often than not. So even though Wall Street is predicting just 4.6% earnings growth, we could easily get 9% or more. And finally, not all earnings reports fall neatly into earnings season. There are 20 or so companies with weird fiscal years that end up reporting ahead of the rest, like Nike and ConAgra, whose fiscal years run through May. One study found a 71% correlation between upside surprises on earnings and revenues for early reporters and upside surprises for remaining companies. And this earnings season, upside surprises for the early reporters look solid. So fingers crossed, maybe we're in for a few weeks of healthy financial results. On now to inflation. Jackson, my inflation music, please.

Yeah, I'm going to need something more specific than that.

I mean, we've got the fastest inflation since '81. Gotcha. Last week we talked about one forecast for March inflation to come in at 8.5% and for that number to mark the peak. Well, 8.5% is exactly what we got this past week, and many but not all investment strategists are calling it a peak. Used car prices are still up mightily over the past year, but they've fallen during each of the past two months. The price of shipping containers from Shanghai to Los Angeles has been coming down. Gasoline was a big driver of March inflation, and pump prices have come down a bit from their high. Those are all signs that support a March inflation peak. On the other hand, Rents are a big part of inflation, and they typically lag well behind house prices as leases come due. And house prices have soared, so we expect rents to be a big contributor to inflation in future months. Also, producer prices came in up 11.2% this past week, the biggest increase in records going back to 2010. Prices paid by producers can eventually make their way into consumer goods So those are signs that inflation might not have peaked just yet. The big question, of course, is what investors should do about it. Lindsey Bell, the chief investment strategist at Ally Invest, is in Camp Peak.

I think we're hopeful, many market participants are hopeful that inflation has peaked or is peaking in the first into the early part of the second quarter. And there are some green shoots, I think, pointing in the direction that we could be reaching a peak here.

Lindsey says investors need a balance between holding defensive stocks and looking for good deals on more cyclical stocks that have sold off.

Since the beginning of the year, I've been pretty bullish on healthcare for that type of defensive exposure. But you also need to, to take advantage of prices that have come down quite a bit in valuations that have gotten much more attractive. So I think there's some opportunity within the tech space. And then once we get to the other side of this, Some of the cyclical areas that have been quite beaten up and left for dead, like the consumer discretionary or even industrial parts of the economy, I think are areas that are also worth having some exposure to because they're going— that's going to be the part of the economy that pops once we get through this wait-and-see type of mode.

Lindsay is broadly optimistic about earnings season and the state of consumer spending over the summer.

We did a survey of consumers at Ally recently about their travel plans, and 2/3 of consumers are excited to get back out there and travel. And so I think travel is going to be up. People want to get away. They wanna get to relaxing destinations. They wanna unplug. But as far as spending goes, I think they're sticking to the budget they have, and they're being realistic that that budget might mean they might not be able to do all the activities that they wanted to do or buy, you know, Aunt Sally that, parting gift.

Okay, so yes to travel and no to buying a souvenir for Aunt Sally, but let's all agree to get her something twice as nice next year. By the way, last week in this podcast, we heard from an analyst who called Delta Airlines his top airline pick and said he expected good things from its earnings report. Delta reported this past week and. It said March was its best sales month ever. The stock jumped 6% on that report. Now, Christina Hooper is the chief global market strategist at Invesco, and she doesn't think inflation has peaked just yet, but she says a peak isn't so far off. You're a non-peaker. I thought everyone was on the peak bandwagon. I've seen one research note after another. So how long— if this isn't the peak, how long do you think it might take?

Another few months or Yeah, I would suspect another few months. Of course, all bets are off if we see something like an energy embargo, an oil embargo in Europe. But assuming that the status quo remains the status quo, I suspect that we will peak in a few months.

Christina says that the Federal Reserve could raise core interest rates by a half point in May, and that for now it's full speed ahead on rate hikes, but that toward the end of this year and into next year, as inflation comes down, the Fed could slow its pace of rate hikes. She says that for the long term, we could end up with a 2.5% Fed funds rate and maybe a 3.5% to 4% yield on the 10-year Treasury and a 30-year mortgage rate of 6% and change. Mortgage rates are around 5% now, which might look high to house shoppers, but only if they don't remember mortgage rates from decades ago.

I remember the first house I bought— I'm dating myself— was in 1996, and I remember our mortgage banker giving us the mortgage calculator, and there was a sliding scale so you could figure out what your mortgage payment would be based on the, the rate, and the scale was 6 to 20%. And you're here to tell about it.

Exactly.

I'm here to tell about it and tell you that many things have been refinanced since then. Now, so I, I don't think we're getting back to a scale where we're looking at 6 to 20%, but maybe we're looking at 6, 6.5%.

Christina says that a typical 60/40 investor with 60% stocks and 40% in bonds should think about becoming a 55-30-15 investor with a 15% in alternative investments, especially commodities.

From my perspective, be well diversified in equities, but more exposure internationally than perhaps we have had in the past few years. Within fixed income, we want to make sure we have inflation-protected securities in there, but also maintain a well-diversified fixed income portfolio. We're certainly seeing yields go up a bit, and that's a positive. And then within alternatives, make sure we have adequate exposure to commodities as well as real estate, and then perhaps a little bit of gold in there. But I would argue not as a great inflation hedge because it has a spotty history there, but as a geopolitical risk hedge.

Finally, I asked Christina which markets outside the US investors should be favoring now, and she says she likes Japan, where inflation remains low and China, where stocks have fallen on concerns over government policy and reporting requirements for overseas listings. She isn't as bullish on Europe.

Right now is going to be a difficult time for European equities. It's hard to be as enthusiastic because they're close to the epicenter of this crisis and certainly feeling the brunt of that. There is an opportunity in Japanese equities, in my opinion. The Bank of Japan is in a very different place than other major developed central banks in terms of its monetary policy. And so that should be supportive. Also Chinese equities. There had been this view that China had been rendered uninvestible because of surprises in terms of regulation and policy that was rolled out. I actually don't believe that's the case. I think it appears as though we're not going to get the level of regulation going forward that we saw in the past year. And we're also going to get more transparency and messaging in advance of that.

Thank you, Lindsay, Christina, Austin, and Mike from Colorado. And thank all of you for listening. If you'd like to ask a question on the podcast, just tape it on your phone, use the voice memo app, and send it to jack.hough@barons.com. Jackson Cantrell is our producer. Jackson, you're off next week. I can handle the technical stuff. How many hertz do we generally use?

I really can't tell if you're bluffing right now because Hertz is actually almost a thing, but I think Meta will have it covered because she's producing next week.

So gotcha. Subscribe to the podcast, write us a review on Apple, and follow me on Twitter. That's @JackHowgh.

See you next week. Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.