Weekly CEF Market Report - May 30, 2021
Weekly CEF Market Report - May 30, 2021
Macro Picture
Stocks eked out some small gains this week bringing the S&P 500 within a half a percent of the all-time high hit on May 7th. We saw a small rotation back to small caps and technology as the Nasdaq and Russell 2000 outperformed handily.
The major indices were fairly steady for most of the week with volatility subsiding. The VIX fell to 16, the lowest levels in a few weeks and near the post-pandemic lows. This is obviously good for closed-end fund discounts to remain relatively tight.
Investors kept a close watch on economic data coming out this week including durable goods, jobless claims, and regional manufacturing gauges. The data was mostly mixed with the durable goods orders (a leading economic indicator) rising 1% in April. Jobless claims came in at a pandemic era low of 406K. But the regional manufacturing surveys came in weak along with consumer confidence data.
Concerns about inflation resulting from supply chain pressures and the release of pent-up consumer demand may have also restrained the week’s gains. The Commerce Department reported on Friday that its core (less food and energy) personal consumption expenditure price (PCE) index increased 3.1% in the year ended in April, slightly above expectations and the biggest increase in nearly three decades—and well above the Fed’s 2% target for its preferred inflation gauge.
Commentary
Discounts climbed back to their tightest levels of the last 8 years with munis starting to catch up to taxables. The spreads between the two are down to 1.47%. I still believe that eventually muni CEFs will trade at a higher premium than taxable CEFs.
We are reaching the upper bounds of where discounts have historically gone. I do think we have about 6-9 months left before we start seeing those discounts widen back out- AT THE MOST.
All the lemon juice has been squeezed out of the lemon (i.e. high yield spreads) today. The BofA High Yield OAS spread is sitting at 3.3%. Very close to the tights achieved over the last decade. So NAV gains from here will be hard to come by.
Discounts are now at a premium. Thus, given the natural ceiling in investors not wanting funds that trade at a premium, there is little upside left there as well. The combination of tight spreads and expensive discounts is hard to swallow for many investors. As I've been commenting for weeks, your choice is to accept it and hold or rotate out and cut your income.
This is evident using the below fund as an example, Wells Fargo Income Opps (EAD). The NAV has mostly been flat for the last few months while the price continues higher, closing the discount. Obviously, this can only occur for so long as at some point, the incremental CFE buyer will no longer be willing to pay such an expensive price for this fund. When a CEF trades at such tight levels relative to its historical average discounts, there "discount risk" or risk that the discount widens out substantially, increases.
I continue to rotate my non-Core positions (and even some of the Core in increments) into cheaper funds attempting to produce alpha. The results are mostly mixed but positive.
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