Weekly Commentary | January 27, 2019

For all the new members, we break down our weekly commentary in a few different sections.  

  1. Week in review of the markets

  2. Macro economic update

  3. Closed-End fund news/corporate actions

  4. Statistics of the week (showing CEF data)

  5. Commentary on CEFs

  6. Deep dive analysis on specific areas of CEFs or other securities

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After four consecutive weeks of strong gains in the equity markets, stocks took a breather on the shortened holiday week.   They did end the week on a high note as news about the U.S. and China being "miles and miles apart" was offset by the possibility of the Fed ceasing the roll-off of the balance sheet. and the government shutdown coming to an end.

The Dow and Nasdaq rose slightly but the S&P 500 fell 5 points.  YTD, the S&P 500 remains up 6.30%, the Dow +6.04%, and the Nasdaq +7.98%.  Midcaps are up 9.29%, and small caps +9.89%.

Given the shutdown, there has been a dearth of government data so the only thing we have seen is overseas.  Given the increasingly globalized world, Japan, China, Germany, UK, and France are key drivers for our economy.  Those economies appears to be slowing rather dramatically.  Germany appears to be entering full blown recession, joining Italy who entered several months ago.  France is likely not far behind.

Earnings season continues to ramp up and the early part of the reporting season has been better than expected.  The reported numbers are coming in ahead of lowered expectations but guidance is decent and the tone by management upbeat.  That is especially true of the banking sector where a number of the largest bank CEOs were positive on domestic growth for the year. 

Also more positive - and something that could be an upside surprise catalyst for 2019- is Chinese growth stabilizing.  The country has been slowing down over the past two years but there are signs it could be bottoming.  December retail sales and industrial production results both came in ahead of expectations.  In addition, President Xi has been pulling multiple stimulus levers to increase growth.  If we see a 2H 2019 increase in Chinese output, it would definitely be a surprise and counter the current negative narrative. 

Onto the Fed which has moved in a dovish direction compared to two months ago.  It appears that they are now fully on pause in terms of raising rates- the next possibility is likely the June meeting allowing another six months of data to flow in before moving again.  If the economy continues to chug along, they will raise rates.  But watch the bond market.  If spreads remain wide, they will likely pause further.  

The timeline of events the last two months is interesting.  Following the last increase in the Fed Funds Rate in December, the post 12.19 press conference was likely the driver of the markets lower.  In it he indicated that the balance sheet would continue to shrink regardless of the macro environment.  Just a few days later, Powell was on a panel with Yellen and Bernanke and read off notecards that walked back the 'autopilot' comments.  On the 25th, the WSJ published an article summarizing the recent (last four weeks) comments by Fed officials.  

I would think that the Fed is likely to continue the current policy of roll-off, as the market has stabilized.  Credit spreads have stabilized around 4.45 but are not falling back further (they did reach 4.27 on Tuesday).  Interest rates were also stable on the week down two bps compared to last Friday's close.  

In general, the year is shaping up to be another where large caps do better than small caps, domestic better than international (EM may be the exception), and interest rates slowly rise.  

Below is the ECRI Weekly Leading Index.  This is a private economic research firm that puts out their own leading indicators.  It has turned negative several times this cycle and so far it is only modestly negative though it bears watching.

The 10-year remains in no-man's land and is looking for direction.  This is something to keep a close eye on over the next week or two, especially as the Fed has their January meeting on Wednesday.  Remember, all Fed meetings in 2019 are "live" events.  While there is virtually zero chance of a rate hike, the presser and the Q&A session will provide a lot of insight into their current thinking and courses of action.  

Closed-End Fund Analysis

Distribution Increase

N/A

Distribution Decrease

ClearBridge Nrg Midstream Opp (EMO):  Quarterly distribution was decreased by 28.1% to $0.23 from $0.32.

ClearBridge MLP & Midstream TR (CTR):  Quarterly distribution decreased by 24.1% to $0.22 from $0.29.

ClearBridge MLP & Midstream (CEM):  Quarterly distribution decreased by 16.9% to $0.295 from $0.355.

Activist Buying

MFS CA Muni (CCA):  Saba Capital Mgmt owns 387K shares or 13.9% of the outstanding shares, a 12.6% increase.  

Statistics

These are the top and bottom funds in our Core set of funds:

These are the top and bottom funds across the entire CEF universe:

Commentary

Discounts across the CEF universe tightened by another 20 bps this week to an average of -6.88%.  One thing we look at on a weekly (and monthly) basis are the changes in the general CEF space for a health reading.  Below is the data for the last two weeks.  You can see aggregate price rose by a couple of pennies while aggregate NAV fell by one penny- closing the discount a bit.  Of note, we are now at a positive z-score reading for the first time in many months.  

On the Core, ARDC was one of the best NAV movers, again.  From most perspectives, this is still one of the best opportunities in the taxable bond space today.  At a 14.35% discount, nearly 4 points below the one-year average, a yield of ~9% and strong NAV trends.  The one-year z-score is still -1.40, one of the few "bargains" left after the strong run in January. 

From a technical perspective, many of the indicators we follow are bullish at the moment.  MACDs are squarely positive (as they have been for a few weeks) and money flow is helping.  In addition, if the Fed is done or nearly done (including with the balance sheet- again we are skeptical of this and think the market is too dovish), it would be superbly positive for fixed income CEFs.  

While we wont be buying much this week- if anything- we likely won't be selling much either.  The best opportunities today remain in the funds that are "high quality" (meaning they have high coverage, higher NII yields, still value z-scores and are in sectors we like).  

  • ARDC

  • AFT

  • DSU

  • TSLF

  • BGB

Another fund that appears attractive is Western Asset High Yield Def Opp (HYI).  This is a term trust fund meaning it self liquidates at a certain date in the future.  This is different than a target term fund that liquidates at a certain date in the future and at a certain price.  HYI will liquidate at whatever NAV it is on the date of expiration.  That date is September 30, 2025.  

At a discount of -13.25%, the fund is giving you over 2% of "juice" per year between now and liquidation.  Anytime a term fund gives you over 2% per year in added return, it becomes attractive.  

And at the same time, this fund meets all our criteria with high coverage, high yield, and one of the lowest z-scores in the taxable space at -2.20.  The NAV has been stable to slightly increasing in the last two weeks while price is down giving the current opportunity.  Watch for further analysis in the near future.  

Nuveen CEFs Update

Nuveen recently released the December numbers for their closed end funds, both taxable and tax-free.  

On the taxable side, the floaters took a hit to coverage, which is not surprising given the fall in the index.  Still, most ratios are above 100% except for JSD.  From a coverage and UNII perspective, I do not see anything that would concern me for a distribution cut, especially since January has been such a strong month.  On the preferred side, coverage has been consistent for over six months now.  All four funds have been growing UNII comfortably.

Recently merged NBB, their taxable muni fund, saw coverage decline despite the scale that is typically achieved in combining funds.  

On the muni side, Nuveen's high yield muni bent has been a benefit to their fund complex.  Coverage has been relatively stable and not seen the same magnitude of decline as in years past.  On the nationals, there are nine funds out of sixteen with coverage in excess of 100%.  Only three funds have a positive UNII balance.  

The 3-month stacks on both UNII and coverage are great trend indicators for us.  And obviously the color-coding conditional formatting helps identify the outliers.  In coverage, our call on Nuveen Municipal High Income (NMZ) appears well timed.  The fund continues to build both its sponsor-leading coverage (106.1%, up from 105.8% last month) and its UNII bucket (+2.2 cents, up from +1.7 cents last month). 

Further thoughts on NMZ

The fund continues to close its discount to NAV after reaching a 12.3% discount in late December.  We had it as our top fund to buy today for discount capture.  Since that update (read HERE), the discount has halved and is close to the 52-week average.  The fund had cut the distribution twice in the last year which created the opportunity as the discount blew out.  

Why did they cut when the distribution was covered with room to spare?  Perhaps they modeled 100% of the calls being replaced with lower coupons and perhaps that didn't occur.  The call schedule for the next several years is decent with just 7-8% each year for the next three years.  We opined a few weeks ago that the average bond price of $99 being under par suggested that half of the portfolio would not be hurt by a par-call.  In other words, the call of those funds that are trading near par isn't a significant negative for the fundamentals. 

Credit quality is mostly investment grade with ~17% in non-investment grade and another ~26% in unrated positions.  

The z-scores show that the fund, after making such a strong move higher, is only now fairly valued, not over-valued.  One-year z-score is +0.20.  

While a large part of the discount convergence trade is likely mostly done, there is probably still some juice left, in our opinion.  In the meantime, the distribution is one of the best offering a yield of 5.48%.  The one thing we want to watch closely is the NAV performance which hasn't been all that stellar compared to other high yield funds.  

Quick Muni Update

On the note about Nuveen funds above, we thought it would be good to revisit the muni space given the movement of the funds in the last month.  

This is from our January 8th Muni Market Update:

Buy Today For Discount Capture:

Nuveen High Income Opps (NMZ)Eaton Vance National Muni Opp (EOT)Delaware Invest CO Muni Income (VCF)Blackrock MuniYield Invest (MYF)Blackrock Muni Income Inv (BBF)

Buy-And-Rent (HOLD)

Mainstay McKay DefTerm Muni Opps (MMD)MFS High Income Municipal (CXE)Dreyfus Muni Bond Infrastructure (DMB)Invesco PA Value Muni (VPV)Nuveen High Income (NMZ)

Many of those discount capture opportunities have closed significantly.  For example, EOT was trading at a -7.3% discount a few weeks ago.  Today, the fund is right at par.  That is a massive move higher in a short amount of time.  

Another, VCF, went from an 8.3% to a 5.03% discount.  That one, we think, still has a bit more room to run.  We think there is at least another point or two to go.  

MYF was at a -7.7% discount and is now at a 4.1%.  This is another one that has moved nicely but probably has a point or two left to go so we wouldn't sell.

BBF was near a 10% discount and today trades at 4.8%, below the 52-week average of 5.7%.  This one is probably close to being done.  

We will be doing more of an update next week with further analysis including on how much beyond the 52-week average some funds could go.  

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