Weekly Commentary| March 3, 2019

Stocks again moved higher for the longest weekly gains in nearly 25 years.  Materials and utilities were the leading sectors.   The S&P was up 0.65% with the Nasdaq up 0.74%.  Small caps rose by 1.34%.  For the year, the S&P 500 is now up 11.74% and the Russell 2000 is up 18.08%.  

In fixed income the Barclay's AGG rose another 11 bps and is up 1.21% on the year while high yield gained another 35 bps to 5.89% on the year.  Munis were also up on the week approximately 16 bps and are now up 1.21% YTD.

Interest rates continue to hold in a tight range between 2.65% and 2.72%.  We still do expect them to break out on the higher side.  Of course, with the market zooming and due for at least a period of consolidation if not a small pullback, there is a shorter-term risk to that forecast.

Oil was up another $2.50 on the week and hit $58 briefly Thursday before pulling back a little.  Meanwhile, the all-important VIX fell to a 13-handle on Thursday but rose slightly to 14 by the close on Friday.  That is down from 15.6 at the end of last week.  

The key news on the week was the progress being made on the trade front with President Trump stating that the March 1st deadline was flexible as they near a deal.  We also got the Fed minutes this week for the January meeting which stated that all participants thought it was a good idea to stop reducing the balance sheet later this year.  Officials also noted that they favored a patient approach to monetary policy that would allow them to monitor the data.

SPX macro update – US equities headed for a period of digestion but the SPX should stay within 2750-2800 - the bar to impress the SPX is much higher than it was back in H2:Dec and H1:Jan and thus the index could struggle for the time being. At this point it would take the instant removal of existing US-China tariffs, a sharp upward inflection in Chinese growth, and ending reserves on the Fed balance sheet of ~$1.3T to “surprise” US investors on the upside. The 2019 SPX EPS consensus remains ~$172.50 (on Thomson Reuters) and the present PE isn’t ridiculous (16.1x) but it isn’t extremely cheap either. Positioning/sentiment are still tailwinds but not nearly to the extent they were a few months ago. The SPX will likely break up through 2800 by the summer but the path forward won’t be as linear as it was since 12/26 and a trip back towards ~2750 could easily occur during the upcoming period of digestion.

• The ingredients for a break in the SPX above 2800 – the following macro developments need to occur to get the SPX north of 2800: 1) the Fed confirms plans to complete balance sheet normalization by the end of 2019 and commits to keeping reserves at $1.25T or more; 2) the Fed more explicitly signals the end of rate hikes (this has been strongly suggested but the recent minutes left the door open to additional tightening actions); 3) the ECB delivers on the market’s LTRO expectations; 4) Chinese growth continues to stabilize and inflects higher; 5) the US and China reach a trade compromise and Trump avoids other trade-related battles (in particular, Trump backs away from his auto threats); and 6) US growth momentum doesn’t decelerate dramatically. Bottom Line: this scenario is likely to occur but it may not be apparent for a few more weeks and thus the SPX will likely tread water for the time being.

Thoughts

We still continue to believe that at least one rate hike is likely this year - probably at the June meeting.  But it will be highly dependent on the market expectations.  Chairman Powell learned his lesson about going against market sentiment when raising rates.  

From a technical perspective, the market continues to break out and approach new highs but I do fear a 'sell the news' rally should we get a deal with China.  In addition, earnings will be fairly flat this year which should prevent a large multiple expansion in the index capping the upside from here a bit.  

Closed-End Fund Analysis

Distribution Increase

Western Asset High Income Opp (HIO):  Monthly distribution increased by 9.4% to $0.029 from $0.0265.

Gabelli Health & Wellness (GRX) increased their quarterly distribution by 7.7% to $0.14 from $0.13.  

Western Asset Global High Income (NYSE:EHI):  Monthly distribution increased by 1.6% to $0.062 from $0.061.

Western Asset High Income II (HIX):  Monthly distribution increased by 1.1% to $0.046 from $0.0455.

Distribution Decrease

First Trust Sr Floating Rate 2022 Target (FIV):  Monthly distribution decreased by 15.4% to $0.0353 from $0.0417.  

Wells Fargo Global Div Opp (EOD):  Quarterly distribution decreased by 3.5% to $0.14881 from $0.15413.

Activism

Special Opportunities Fund (SPE):  Shaker Financial is building a position and now owns 5.02% of the shares.

Blackrock Funds:  Karpus is building a position in several funds including MYI (6.7% of shares), BKT (16.3%), BYM (5.51%), MHN (5.44%)

High Income Securities (PCF):  This formerly Putnam run fund has Karpus owning 9.5% of the shares.

1607 Capital Partners LLC

 The hedge fund is building positions in Aberdeen Emerging Market Equity (AEF) where they own 7.5% of the shares.  Aberdeen Total Dynamic Div (AOD)- 8.24% of shares, Aberdeen Japan Equity (JEQ)- 21.15%. Korea Fund (KF) - 9.2%.  Blackrock Enhanced Global Div (BOE) - 5.51%.  European Equity Fund (EEA) - 20.3%.  D&P Utilities (DUC) - 5.07%.  First Trust Dynamic Euro (FDEU) - 5.01%.  EV Short Duration (EVG) - 5.64%.  JH Investors (JHI) - 8.2%.  JH Income Sec (JHS) - 6.26%.  MFS Ind Income (MIN) - 8.95%.  MFS Emerging Market (MSF) - 7.58%.  

Karpus Capital Management

 Building positions in D&P Utility Corp (DUC) - 14.6%.  EV CA Muni Income (CEV) - 6.35%.  EV Muni Bond (EIM) - 10.4%.  EV NY Muni (ENX) - 5.9%.  Aberdeen Global Opp (FAM) - 12.4%.  Gabelli Health and Wellness (GRX) - 5.6%.  High Income Securities (PCF) - 9.4%.  JH Tax-Adv Global (HTY) - 11.9%.  Western Muni High Income (MHF) - 5.9%.  Nuveen AMT-Free Quality (NEA) - 5.2%.  Nuveen NY AMT- Quality (NRK) - 8.1%.  Nuveen NY Muni Val (NYV) - 7.1%.  Pioneer Div High Income (HNW) - 7.3%.  Prudential Global Sh Duration HYY (GHY) - 5.75%.  

Commentary

Senior loans (a.k.a Floaters) finally saw some material discount closing this past week.  Most of that came on Thursday and Friday as prices jumped over 1% in many cases.  The driver for it is unclear.  It could be that it was the last bastion of value in the bond space of the CEF market.  Or perhaps sentiment is shifting a bit given the rebound in the equity markets that another rate hike (or more) is back on the table.

We will be issuing a separate report in the next day or so in the floating rate space with some top trades.  I'll try to get it out as soon as possible.  

We would just note that it pays to be patient when holding these securities.  The Leveraged Loan Index still sits at or just below $97 so there's an opportunity for more NAV gains, in addition to the pricing gains we've seen this past week.  If you look at the sector list in the statistics section, you can see that while senior loan NAVs rose about 54 bps, prices rose by 250 bps, closing the average discount by 2 points.

Moving On....

We now have many funds that are under a 'sell flag' for the first time in over 7 months.  This is not unusual given the sentiment driven nature of the closed-end fund space.  At various times, we have a dearth of buyers that can send prices plummeting and discounts widening (December is a great example).  At other times, there are no sellers and even a marginal amount of new money can send prices higher and discounts tighter.  

Investors need to make a choice here if they want to continue to collect income and hold, or sell and move into something else while waiting for better valuations.  The problem with the latter, which is more of a total return approach, is it can take months if not longer for those valuations to present themselves.  

We noted on the chat that members are susceptible to some groupthink and to be careful you do not become too conservative.  Many members are selling and raising large amounts of cash.  If that is part of your overall portfolio plan, then so be it.  But do not stray far from your target allocations just because we rebounded to where we were in late September (or near it).  Funds can continue to see increasing demand and rising values for a long period of time. 

In 2016 and 2017, we saw very little volatility and 'cheapness' after nearly two years of it prior (2014-to-early 2016).  In other words, after what was a painful quarter, we could be done with the pain for a while.  Obviously it is impossible to know that.  Just a word of caution.  

While I continue to trim our holdings a bit, each needs to consider what is their personal situation. Are you retired?  Are you in accumulation mode?  Are you drawing on the portfolio?  How risk averse are you?  What is the need for yield like?  If that yield were cut in half, what would happen?  

I sit on about 15% cash (just a hair above the long-term average I have typically held).  This past week I sold IHTA, HYI, a small amount of VPV, PCI, and PDI.  I did add to TSLF, DHY, LOR, and PPT.

Nuveen Update

Nuveen released their January numbers on Friday.  The muni side showed a continuation of prior trends with some UNII build and coverage improvement.  Remember, Nuveen cut their muni CEF distributions significantly over the last year-plus in an effort to stem the 'call problem' and rebuild UNII.  That appears to be working well.  

The top coverage on the national muni side is (NMZ) which increased coverage to 108.1%, up 2 points from last month.  UNII also continues to increase and is now at 2.7 cents, up from 2.2 last month and a negative reading back in August of last year.  It remains our top pick.

Other funds that are doing well from a fundamental standpoint are NAD, NIM and NXC (CA muni).  That doesn't mean they are cheap by any means.  

Nuveen Muni CEF UNII:

Nuveen Muni Coverage Ratio:

Update On MINT (Safe Bucket Holding)

PIMCO Enhanced Short Maturity Active ETF (MINT) is our preferred cash-substitute.  That does not mean it is pure cash or as safe as cash but it exhibits "cash like" characteristics in terms of volatility and credit risks.  I think the best way to demonstrate the risks are through a series of charts related to performance.  

The first is the total return in price from the market peak in late September through the trough on Christmas Eve.  You can see for most of the downturn, MINT was rising in value.  The fund peaked in mid-November and then rolled over in December.  But the y-axis (right side) shows you the level of volatility.  The fund went from a +0.24% increase and fell back to +0.18% for a difference of just 6 bps.  

4.png