With unemployment below 4% and inflation metrics high, we could be looking at a period in which the Federal Reserve raises interest rates. Perhaps more importantly, this week’s minutes from the December Federal Reserve meeting showed officials are thinking about shrinking the Fed’s balance sheet soon, which was quicker than anticipated.
Tightening financial conditions and rising rates pose the risk of slowing the economy too much, but the reason for this new hawkishness is that the economy is running hot. If rates rise, but not so much to tip the economy into recession, low-priced value and cyclical stocks could continue to outperform in 2022 as they have in the first week.
If value and cyclical stocks continue to shine amid a strong economy in 2022, the following three stocks still look like absolute bargains.
Bank of America: conservative, interest rate-sensitive, and a Buffett fave
If were talking value stocks, one shouldn’t be surprised a Warren Buffett favorite made my list. So why does Buffett love Bank of America (NYSE:BAC) so much, enough to make it his second largest position?
It’s probably a combination of two factors. First, Bank of America has pursued a strategy of “responsible growth” under CEO Brian Moynihan, using its scale to make low-risk loans to low-risk consumers and businesses at low rates. Second, it is one of the big U.S. banks that would disproportionally benefit from higher rates.
Bank of America can afford to compete on low rates because it has an outsize portion of its funding coming from low-rate deposits. Bank of America has invested hundreds of millions in digital technology and expanded to new cities. That nationwide footprint has allowed it to collect tons of consumer deposits that cost it nearly nothing. Even more impressively, it has been doing so while keeping operating expenses flat, letting headcount roll off because of retirement, rationalizing the branch footprint, and cutting other legacy costs.
The huge deposit base totaled nearly $2 trillion last quarter, with over $1 trillion coming form low-yielding consumer deposits, up 15% year over year. That gives Bank of America the dry powder to deploy into new loans as interest rates rise. After decreasing loans throughout the pandemic, loans began to tick up again quarter over quarter in Q3.
Armed with low-cost deposits and controlled operating expenses, higher-rate loans from rising interest rates would have most of that extra revenue falling straight to the bottom line. Management estimates a 1% parallel rise in interest rates would yield an extra $7.2 billion in net interest income off of the same asset base over the next year. That would be a 17.2% increase in net interest income over the past 12 months.
When you consider that, Bank of America’s P/E ratio of 14 makes it look like a bargain stock you can still buy today, despite recent strong performance.
Pioneer Natural Resources’ dividend is about to skyrocket
Another conservatively run, dividend-paying company in a pro-cyclical sector is Pioneer Natural Resources (NYSE:PXD). This shale player has distinguished itself by concentrating on the highest-margin shale patch — the Midland Basin of the Permian shale in Texas. In fact, Pioneer just sold its Delaware Basin assets for $3.25 billion, bolstering its balance sheet to become a “pure” Midland play.
The concentration affords Pioneer extremely low costs per barrel, guaranteeing profitability in all but the most dire oil price scenarios. And for those worried about climate change, Pioneer’s assets and operations are among the least carbon-intensive oil production in the entire world, even below that of the low-intensity U.S. shale patch as a whole.
Meanwhile, the company just recently employed a variable dividend strategy, in which it will limit production growth to 5% and pay out most of its free cash flow in the form of dividends, consisting of a base dividend and variable dividend based on how much cash it generates every quarter.
For Q3, Pioneer paid a base dividend of $0.56 and a variable dividend of $3.02. That $3.58 dividend equates to a 7.2% yield at today’s stock price. Yet even that mouthwatering yield looks set to rise further. Management just announced a 10% increase to the base dividend to $0.62 per share. Furthermore, the third quarter still had some hedges in place, all of which were sold in Q4. The company’s realized price per barrel of oil equivalent in the third quarter was only $52.79.
Of course, oil is now hovering near $80, there are hedges off, Pioneer’s balance sheet is fortified with excess cash, and management already disclosed that it repurchased $250 million in stock last quarter. Look for Pioneer’s hefty dividend to rise even further and for the stock to become a huge cash cow in 2022.
Kulicke & Soffa is the cheapest way to play the semiconductor boom today
Even though high-growth profitless technology stocks have been hammered lately, “commodities of tech” — those being semiconductors — have done much better. And that’s no surprise; we are currently in a semiconductor boom, and semiconductor stocks are generally much cheaper than high-priced software stocks.
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