Interest rate cuts are finally coming. When that will be still remains up in the air, but the bond market and interest rate futures contracts are all signaling lower rates in the September to December period. Lower interest rates being paid by the Treasury as a risk-free rate of return should make dividends more attractive because companies do not ever like to lower their dividends. Some companies will even be raising their dividends. Two that are under close scrutiny are in the financial services sector.
Oggonomics is looking for the large companies with dividends that should be more attractive than their peers in a rate-cutting environment. One attribute has to be dividend coverage, but another attribute is that the stocks of these dividend payers had to be hurt by higher interest rates. And in the case of these two financial stocks, there is more to the story than just rate cuts as a catalyst.
It may seem easier to take the cynical view that Jerome Powell and the Federal Reserve have become so used to higher rates that there is no way they will cut rates right before the election. Again, the financial markets with trillions in exposure are forecasting that the next move in rates is lower. And Jerome Powell even fessed up in Jackson Hole on August 23 — “The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks.”
So, which dividends does Oggonomics see as having more upside than peers as interest rates are soon to be heading lower? Keep in mind that this is not intended as financial advice and it does not constitute a recommendation to buy or sell any of these or other stocks. All investment decisions to buy, sell or hold stocks need to be conducted with each investor’s own financial advisors.
These have a minimum of a $10 billion floor for market caps and they have dividend catalysts other than just the expected upcoming rate cuts predicted in Fed Funds futures and by the CME FedWatch Tool.
THE BROKER WITH BANK WOES
The Charles Schwab Corporation (NYSE: SCHW) has been stuck in a depressed mode since it’s last earnings report. The stock has not really done very much at all since that Oggonomics view of “avoid, for now” but lower interest rates will help the financial trading and investing platform with rates it has to pay on deposits. Lower rates will also help its mark-to-market comparisons on loans it plans to sell off from “banking” related operations.
When Schwab issued its disappointing report in July, shares fell from $75 to $62 due disappointing “bank related” woes and due to investment customers moving money elsewhere or into other assets for higher short-term rates. Now those shares are still only back to $64 at this time. If rising rates hurt the company’s marks this badly, then the inverse of rising rates should help Schwab out. Some impatient investors may want to wait for clearer skies here.
Schwab’s dividend is very low for a financial stock and should be considerably higher once its earnings normalize. Schwab was subject to the Fed’s stress test in June-2024. While some metrics were concerning, its strong capital levels showed Schwab as having the highest post-stress ratios among all major banks. That’s also because it isn’t leveraged like a traditional bank and it screens as a capital markets stock within the S&P 500 financials rather than a bank holding company. Is it possible that trimming down its direct banking efforts might eventually get it out from under Federal Reserve scrutiny? Still, Schwab is not handily growing earnings as much as other financials and its adjusted earnings per share are not really better than pre-pandemic levels.
About $150 billion worth of Schwab’s balance sheet were shown to be earning only 1.7% on average. While those are supposedly being held to maturity, it’s well below the 5% and higher rates than can be earned today and some of these assets get marked-to-market against earnings. Much of Schwab’s future growth is expected to come from net asset growth and it already counts some $9 trillion or more in total client assets. Schwab’s stock is still at levels seen back in 2021. If lower interest rates are not going to help Schwab here then its investors and shareholders alike will know that a new leadership is going to need to take over.
ASSET MANAGER TROUBLE
Franklin Resources, Inc. (NYSE: BEN) has an $11 billion market cap. It is currently the worst performing stock among all asset managers worth $2 billion or more. Its stock is down almost 30% YTD and down almost 20% from a year ago, with recent news adding insult on top of injury. Franklin spent $101.5 million buying back its own shares in Q2-2024 alone.
Franklin’s news flow covers controls over trading-related matters that include marks (to-market) of treasury derivatives and also such poor investment performance of its Western Asset Management Macro Opportunities fund strategy. In July, the asset manager disclosed, following the launch of an internal investigation regarding Western Asset Management accounts, notification of dual US investigations by the SEC and Justice Department (Wells Notice). And now in August Western placed co-Chief Investment Officer Ken Leech on leave. That leave is “effective immediately” and Franklin announced that closing its Macro Opportunities strategy with about $2.0 billion in assets was in clients’ best interests.
The stock at $21 now generates a dividend yield of 5.9%. That is artificially high of sorts, because the $30 share price a year ago would look like a normalized 3.8% to 4.0% depending on dividend hikes or earnings. The company is paying out about half of current EPS in dividends so expecting any radical dividend hike may be unrealistic. Franklin has Franklin Templeton’s high international fund exposure and its non-U.S. business ended with $492 billion in assets as of June 30, 2024. As U.S. interest rates are poised to go lower, that will help to normalize some of the dollarized swings in the currency that can impact earnings per share and potentially help bridge last quarter’s 4.9-point adjusted operating margin decline to 25.7%.
A REAL BANK… AS THE RUNNER-UP!
KeyCorp (NYSE: KEY) is a runner-up in this scenario. The stock has entered into the “strategic bull” zone as a “special situation” after the Bank of Nova Scotia (NYSE: BNS) will invest $2.8 billion into Keycorp for a 14.9% stake. This full analysis has already been covered in depth outlining how its own mark-to-market situation may be helped by lower rates. And the new investment will help its book values.
