Playing The End Of A Fed Rate Hike Cycle

It is not often that I start a piece, here or elsewhere, with a disclaimer, but I feel that I should here. A couple of weeks ago, I bought the stock that I will be looking at today, so if you think that makes it likely that I am simply talking my book, you need not read any further. I would, however, point out that having been trained in dealing rooms, no one position I ever take is for more than a fairly small percentage of my investable funds and, with all due respect to all of you, I somehow doubt that any one of you has enough oomph to move a stock with an average daily turnover approaching half a billion dollars in a meaningful way. All in all, the chances of me using this as an opportunity to front run you guys and pump up something I already own are negligible, to say the least.

So, why do I start with the disclaimer? Because the reason I bought it is important and still valid. In fact, one could argue that events since then have reinforced the logic behind the trade and, while the stock is a little higher now than when I got in, this may represent a better entry point from a risk perspective. 

Regular readers of my scribblings will know that despite generally favoring fundamental analysis over technical patterns, I do use a simple form of Elliott Wave analysis quite often to find an entry point for a stock that I believe has some value. That is what happened here with NextEra Energy (NEE).

As you can see, NEE has, since its Q1 earnings release in April, followed a classic Elliott five wave bearish pattern with three increasingly large drops in percentage terms and two decreasingly powerful retracements. However, that bearish move finished on July 11^th when the stock bounced strongly off an intraday low of 70.85. When it opened higher again the next day, that was my buy signal and I got in at an average of $72.45. The chart also indicates that it hasn’t been plain sailing since then, with a move up to $73.93 immediately, and then quite a sharp retracement. Crucially, though, that retracement stopped short of the $70.85 low, and has been followed by another bounce.  All of that indicates the beginning of another Elliott pattern, this time bullish, with a couple more upward moves to come.

So much for the technical analysis that justifies the entry position, but what about the fundamentals? NEE, as you may know, is the former Florida Power and Light. It was one of the first utility companies to invest heavily in wind and solar power, putting it ahead of a trend that has been encouraged and subsidized by governments for a while. They have shown significant growth, even as some other utilities have struggled, in part because the series of mild winters that have cut demand for power for heating in other parts of the country haven’t, for obvious reasons, had much impact in Florida.

Despite that sustained growth, though, NEE has lost significant ground this year, being down around 20% from its high hit last August.

That poor performance is typical for a utility company over that time and is for a somewhat obvious reason. Lest you missed it, the Fed has been hiking rates for a while, and all utilities, which derive at least some of their value from their dividends have been hit as a result. I mean, why take a 3 or 4 percent yield from a stock of any kind when you can get nearly 5 percent from a “risk-free” US Treasury?

Buying NEE, or any other yield-driven asset for that matter, rests on the assumption that that rate hiking cycle is drawing to a close. With the next Fed meeting happening next week and recent inflation data showing a distinct reduction in inflationary pressure, that is not an unreasonable assumption at this point. Even if the Fed does hike again, it will almost certainly be by only 25 basis points and will probably be accompanied by a dovish statement that indicates a pause or even a stop to hikes next month. That, not what they do this month, will influence traders, and something like NEE will get a boost from it.

Nor is that the only event next week that could give NEE a lift. They will report Q2 earnings on Tuesday, the first day of the FOMC meeting. Obviously, that is a risk factor to some extent, but with the company having beaten bottom line estimates on an adjusted basis in each of the last four quarters and with two of the three quality analysts who cover the stock having raised their estimates in the last four  weeks, a negative surprise big enough to break the bullish pattern looks unlikely. If that did happen, it would be signaled by a confirmed break below the 70.85 level, so somewhere around 70.50 makes sense for a stop on the position, with an initial target of a return to around 80 making for a decent risk/reward ratio, too.

In a lot of ways, this article is kind of backwards for me. I started rather than ended with a disclaimer, then began my analysis with a chart pattern, followed by fundamental reasons to buy NEE. That shouldn’t make any difference, though. The fact is that NEE looks attractive at these levels, however you look at it and, as you already know, I have already put my money where my mouth is on this one!