We're in the midst of sector rotation, whereby economically sensitive stocks are well-positioned for gains as the economic recovery accelerates. Which cyclical sectors look best now? The underperformers over the past few months have been utilities, health care, technology, and consumer staples. I think technology will take a breather for a bit after three tremendous years in a row, but I see more relative value in the other underperformers given my expectations for the rest of this year. Utilities had a huge year in 2019, but then pulled back last year. They are still gaining their footing, but I believe that once interest rate fears settle down, they are poised to do well. The energy sector has bounced back better than most analysts expected. Which subsectors of energy look particularly appealing? Energy has been the top-performing sector two quarters in a row, after an abysmal first three quarters in 2020. As long as we continue to emerge from the pandemic, the energy sector will catch back up. But it's still below where it was to start 2020. The exploration and production (E&P) companies have really come on strong, as have the refiners. Some integrated supermajors like Chevron (NYSE: CVX) have had huge recoveries, and others, like Royal Dutch Shell (NYSE: RDSB) are still down from where they were to start 2020. I think you can find the most value, and certainly a good stream of income, in the pipeline companies like Enterprise Products Partners (NYSE: EPD). How worried should investors be about inflation? It's always a consideration, but I don't think it's a worry yet. You just have to make sure your investments are keeping pace. Parking money in a low-interest account is a guaranteed way to lose purchasing power over time. You often deploy an investing strategy called "covered calls." Explain how they work. This is one strategy that has been demonstrated to outperform the markets in the long term. You increase your income stream and buy some downside protection. The catch is that your gains may be capped. Here's how it works. Let's say you own 100 shares of Hewlett Packard (NYSE: HPE), currently trading at $15.72. The company pays a quarterly dividend of $0.12, for an annual yield of 3.1%. I can enter a contract in which I sell an option that allows someone to purchase my shares of HPE by some future date and at a specific price. Read This Story: Selling Covered Calls To Boost Your Income Here is an actual example I looked up as I was answering this. Presently, there is a call option for Hewlett Packard with an expiration date of 9/17/21 and a strike price of $17.00. The premium on this call is $0.65/share, which is more than the total annual dividend of HPE. So, by selling the call, you have more than doubled your effective annual yield. Second, you reduce your cost basis by $0.65, or 4.1%. If shares are at or above $17.00 at expiration, your shares will be called away. (They could be called earlier if the share price rises above $17.00 before the expiration date.) In other words, you will sell them for $17.00 regardless of the price at the time of expiration. However, your reward here is the premium, plus two dividends that will be paid between now and then, and a price that is above the current price. The total return for this transaction, if shares are called away, is 14.4% for a holding period of 157 days. The annualized return is 33.5%. If shares are below $17.00 at expiration, then you keep them and can enter another transaction. Your reward in this case is an annualized yield that was pushed all the way to 12.7%. Some investors don't like the idea of giving up potential upside, but in my experience, you will make more selling calls across your portfolio than you will lose out on in capped upside. And there are studies that back me up on this. Some investors are turned off by options trading. Are covered calls suitable for risk-averse traders? I tell people "Don't trade options. Just sell them." It has been said that most people lose money trading options. So don't be a gambler. Be the casino. Let others gamble, while you bank the certain call premium. In fact, selling calls on your positions is safer than simply owning the stocks, because the calls reduce your cost basis over time. So, for risk averse investors, this is a way to further lower your risks. |
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