Weekly CEF Market Report - May 16, 2021
Macro Picture
We had our first wobble in a while as inflation fears sparked a large down day but the volatility proved short lived. Core inflation came in far hotter than expected which, when combined with last Friday's much weaker than expected jobs report, provided the spark that investors needed to finally sell. But the sell off lasted a whole day as the markets rallied hard on Thursday and Friday to moderate the losses.
Headline CPI (includes everything) rose to 4.2% over the last twelve months ending April 30. That was far higher than the 3.6% expected. This was the highest in nearly four decades. We also had producer prices get reported at +0.6%, double expectations.
But remember, this has a lot to do with the base effect and the year ago figures being so depressed. As we progress through the year, those numbers should start to moderate and by the fourth quarter, begin to head lower. The Fed stressed that inflation should "prove temporary" and that no shift in monetary policy was needed yet.
What was surprising is that yields only moved up slightly and then fell back a bit by the end of the week. Yields have not really moved all that much since the middle of March staying in a relatively tight 10 bps channel.
Commentary
While discounts across the whole CEF sector widened, there were pockets of real weakness and pockets of strength. We saw a small creep up of the High Yield Spread index (a measure of risk for the general bond market) going from 3.25% (and very close to the tightest level) to 3.37%. While that small increase is almost immaterial in some respects, you can see what happened to NAVs last week.
High Yield CEF NAVs fell about a quarter of a point. What I'm trying to show is that you don't need a whole lot of widening to produce negative returns.
Even more important is that discounts on high yield CEFs widened by 0.45% on the week. That means, in addition to losing the 0.25% on NAV, the price fell by an additional 0.4% for a total loss across the sector of 0.7%. So a small wobble in the markets and you lost a month's worth of yield.
That is the problem with investing at these rich valuations.
And investing in funds that are trading at higher premiums (anything north of a +10% premium to NAV) is more problematic. As I noted in my CEF Report, those are the funds that investors tend to sell first. The PIMCO funds got slaughtered on Wednesday as investors dumped rich, higher yielding funds.
PCI and PCI lost 2.1% and 2.7% of their premiums this week. PGP and PHK lost 3.1%. PKO lost over 4% and PFL and PFN lost 3.8% and 2.1%, respectively. In the image above, RA, another high premium fund, lost 4.1% as well.
So does anything look attractive?
Not really. We have now seen these mini corrections in discounts a few times this year but this is the first since late March. But valuations remain very rich. I was surprised that the volatility didn't last more than a day. The spark for the correction was the CPI report which was far hotter than expected. Nearly all risk assets sold off. But a lot of the report was already priced in but I think it took the market a day to see that and flush out the trigger happy sellers.
CPI will continue to trend higher through the summer and likely peak around September. What is interesting is what the 10-yr did this week. If the inflation data was such a surprise, we likely would have seen the yield climb to new post-pandemic highs.
So I continue to "de-risk" extremely slowly adding more individual preferreds and notes (mostly preferreds of CEFs and BDCs) and waiting for better entry points in taxable CEFs. Since I get asked which positions I'm heavy in, here they are:
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