Weekly Commentary | April 7, 2019

The big news on the week was the strong economic data that came out- not just from the U.S. but globally.  We had the China data come out late Sunday night last week that boosted equities in the U.S. Monday morning.  We also had strong manufacturing PMI in the U.S. and then at the end of the week, a rebound in the jobs report.

With the strong stock gains on the week, the S&P 500 is now within 2% of the all-time highs set back in September.  The S&P was up 2.3% on the week, in line with mid caps and small caps.  The Nasdaq trailed a bit at +1.87%.  

Bonds were generally weaker with the Agg down 48 bps and munis down about 26 bps.  High yield did move with equities rising 60 bps on the week.  In fact, the High Yield ETF (HGY) is now back at new highs recovering from the sharp sell off it had in the fourth quarter.  When you factor in the distribution, we are now over 300 bps above that September level.  

The March jobs report showed that 196K new jobs were created.  Last month's tepid report was revised up marginally.  The three-month average is now 180K, in line with most of the last 18 months.  The unemployment rate held steady at 3.8%.  Wages slowed their rise.  

Long-term interest rates rose a bit over the last week helping the yield curve move back to positive territory.  The inversion of the 10yr note - 3-month t-bill has been a cause for investor anxiety the last 10 days or so.  

JP Morgan US Equity Macro Update – at the risk of sounding like a broken record, not much has changed for the SPX. The upcoming CQ1 earnings season should be mixed w/soft Jan-Mar numbers but positive linearity and encouraging qualitative guidance (this has been the message from preannouncements over the last few weeks) – to the extent mgmt. teams speak of improving trends, investors will forgive messy CQ1 results. The question is what happens to ’19 and ’20 consensus EPS estimates – they’ve been drifting lower for months but that process should abate given improving global growth (while the elimination of tariffs could provide a minor boost). However, even though an upward growth inflection is occurring (as was evidenced in the Mar PMI/ISM data), this may only stabilize EPS estimates (at ~$168-170 for ’19 and ~$180-181 for ’20) rather than push them higher. Fed policy is a wildcard – in order for investors to begin adding turns to the PE on account of monetary accommodation, the Fed will need to become “irrationally dovish” but right now it seems quite responsible (if global growth does inflect higher and financial conditions continue to ease w/o the Fed re-pivoting back to a neutral or hawkish policy stance, this would place upward pressure on the PE but for now it isn’t clear whether this will happen). Bottom Line: being as generous as possible on EPS (using the 2020 consensus of ~$181) and assuming a healthy PE of 16x suggests the SPX will face a ceiling around ~2900. An “irresponsibly dovish” Fed could justify ~17x in which case the SPX would surpass 3K but even under that scenario (which is pretty best-case) the upside from here is only ~3.5%.

Overall, the markets and the economy appear to be recovering from the soft patch it had in the late fourth/early first quarters of this year.  While GDP is likely to come in below 2% for the first quarter, the data suggests a re-acceleration this summer and/or back half of this year.  Even to the point where the market- and thus the Fed- may believe another interest rate hike could be in the cards.  

Closed-End Fund Analysis

Distribution Increase

EV Senior Income (EVF): +3% to $0.034 from $0.033.

EV Floating Rate Income (EFT): +2.7% to $0.076 from $0.074.

EV Sr Floating Rate (EFR): +2.7% to $0.077 from $0.075.

Delaware Div & Income (DDF):  +2.1% to $0.0905 from $0.0886

Delaware Enhanced Global Div & Income (DEX): +2.03% to $0.0904 from $0.086.

EV Floating Rate Income+ (EFF): +1.2% to $0.084 from $0.083.

Distribution Decrease

PIMCO High Income (PHK): -24% to $0.061331 from $0.080699.

PIMCO GlobalStkPLUS and Income (PGP): -23% to $0.09394 from $0.122.

Allianz Convertible and Income (NCZ): -21.7% to $0.045 from $0.0575.

PIMCO NY Muni Income (PNI): -21% to $0.040045 from $0.05069.

AllianzGlobal Convert and Income (NCV): -19.2% to $0.0525 from $0.065.

Templeton Global Income (GIM): -18.1% to 0.0336 from $0.041.

PIMCO NY Muni Income III (PYN): -16% to $0.03549 from $0.04225.

PIMCO Strategic Income (RCS): -15% to $0.0612 from $0.072.

PIMCO Muni Income III (PMX): -9% to $0.050733 from $0.05575.

PIMCO CA Muni Income III (PZC): -7% to $0.04185 from $0.045.

PIMCO NY Muni Income (NYSE:PNF): -7% to $0.05301 from $0.0703

Managed Distribution Policy

The fund adopted a managed distribution plan where they will shift the payout to a monthly payment at an annual rate of 6% (or 0.5% per month) of NAV for the remainder of this year. Starting in January of 2020, the fund is proposing to make monthly distributions at an annual rate of 6% based on the NAV on the close of business on the last business day of the previous year.

Our team wrote on this just a few weeks ago anticipating the change.

Activist Buying/Selling

SabaBuying:  MNE, EFF, VVR

KarpusBuying: EIM

SIT AssociatesBuying:  JHSSelling:  EGF, FMY

Commentary

Just a reminder, DSU's tender offer expires in a little over a week.  We recommend voting "YES".  It's a small 5% tender that we don't expect to result in too much in the way of alpha.  Still, the ability to get between 5% and 12% of your shares lifted at 98% of NAV giving you an almost 10% instantaneous gain is a good thing.  On their prior 10% tender offer last year, the proration got you 22% of your shares lifted because so many people didn't vote "yes".  

The discount at -11.26% is attractive given the portfolio.  We are still constructive on floating rate despite the negative flows and the dovish pivot of the Fed.  Yields are still at or near where high yield bonds trade and you get the upside if rates meander higher from here.  71% of the portfolio are term loans (floaters) with another 25% in high yield (fixed coupon) bonds.  

One of the best aspects of this fund is the sector breakdown with technology and consumer non-cyclicals being the top industry types.  Often we see funds that have 'communications' and 'energy' as the top industries which tends to give us pause.

Munis were the weakest CEF sector on the week while equity sectors performed well.  The top price gainer on the week was Eagle Point Credit (ECC) which gained nearly 5%.  The volatility and riskiness of this fund is not understood by the market.  It should be kept as a small allocation if held at all. 

Surprisingly, Nuveen Pref and Income 2022 Taret (JPT) gained 4.2% for inexplicable reasons.  It now sits at a 1.3% premium. 

One of the stat pieces I like looking at are the funds that lost the most premium/gained the most discount on the week.  PIMCO funds, (PGP) and (PHK) were the two largest movers last week with PGP reducing its premium by 23%.  PHK lost 18.3% and seemed to stabilize late on the week.  RCS was third at 12%.  

A quick additional note on these funds.  I have premium targets where these become attractive.  For PGP, the premium would need to fall to below 20% for us to get really interested.  At 31%, it still has a way to go.  For PHK, a fund I don't like as much as PGP, I would want to see at least the low-20% area if not high-teens as well.  

Flex Portfolio Update

Expect to see more trades in the Flexible Portfolio in the next few weeks/months as we harvest some of the gains made and rotate into other, more attractive opportunities.  Let's walk through the positions to see where we are at and our targets for each.

Principal Real Estate Income (PGZ) has been a holding for about 16 months now and has made quite a move in the last four months.  The discount is still relatively attractive at -11.4%.  The ROC in the distribution is the result of the managed distribution policy.  We will continue to watch the NAV and the amount of ROC for signs that the distribution may be cut.  For now, we think it is safe but one of the risks of these types of funds is that you really just never know.  If you hold, I would continue to hold but I wouldn't buy here.

Pioneer Diversified High Income (HNW):  This is a classic example of why buying at an attractive discount can provide a bit of a cushion and produce alpha (superior risk-adjusted returns).  The fund continues to benefit from the recovery in high yield debt.  With a fixed coupon, if rates do rise, this fund should be effected far less.  The discount is tightening and is likely to tighten further given the well-covered distribution yield.  

Blackrock Debt Strategies (DSU) is another we've held for a long time on the basis of activist swarming the fund.  The discount just refuses to tighten despite all the stuff going on including tender offers.  At a -10.9% discount, it is still relatively cheap for the yield.  As we noted above, 22% of shares were lifted last year when they did a 10% tender.  So we expect about 11% to get taken from us this go-around.  The z-score, on a one-year basis, is just now above zero.  It would be nice for this fund to get to an ~8% discount so we could harvest the gains.  For now, we are holding and voting yes on the tender.

Ares Dynamic Credit (ARDCis similar to DSU but has more fixed-coupon debt with roughly 50% in floaters and 50% in HY (DSU is about 72% floaters).  The NAV hasn't been as upward sloping as other funds in the space.  One reason could be the higher amount of level 3 assets due to the CLO positions.   We've added to this fund recently and will likely continue to do so occasionally on weakness.  The fund is up over 11% YTD on price and nearly 7% on NAV.  

Nuveen Short Duration Strategies (JSD) has been making nice progress on closing its discount going from -16% to -7.7%.  Coverage is near 100% but UNII is slightly negative.  The last distribution move was an increase.  The NAV is mostly up nicely as the index continues to heal (overcoming fund flow headwinds).  I want this to get to a -5% discount so i can unload it from the Flex.  Stay tuned.  

NexPoint Strategic Opps (NHF):  This was an opportunistic purchase that houses mostly equity and equity-like positions.  It also has a basket of preferreds for current income and a large position in the NexPoint Re Opportunities LP REIT. Running some backtested factor testing, the fund has most prominent exposure to high yield and REITs.  The discount has tightened but the one-year z-score is still nicely negative at -0.80.   This is one we may add to tomorrow or Tuesday as the NAV jumped significantly, perhaps on a re-pricing of the LP position.  Short-term, I think this could go back to a -9% discount if the NAV is accurate and more medium-term towards 5-6%.

Neuberger Berman High Yield (NHS) was one we bought because of the massive discount and attractive yield despite not loving the sponsor (Neuberger Berman) too much.  The discount is nearing its target of -9% and we consider this position a source of cash- mainly because the yield isn't as competitive as other similar risk funds out there.  Be on the look out for a sell-alert when we his that target and/or find a suitable replacement.

Credit Suisse High Yield (DHY) was a recent opportunistic buy in a fairly liquid (low-share price value) fund.  The position is relatively small at ~3% and has not only gone to 'hold' but to a 'sell' rating at $2.53 (from $2.35).  The yield is still high at 9% but the portfolio is pretty junky.  For those wanting to de-risk, I would let this go now and wait in cash for something else to materialize.

Lazard Worldwide Dividend & Income (LOR) cut the distribution starting with the January payment by 21.7%.  It is also going through a merger with sister fund LGI.  LGI will be the surviving fund.  They also announced a tender offer for 20% of the funds outstanding shares at 98% of NAV.  That offer has not yet begun but we expect to fully participate hoping to get about 40-50% of our shares lifted at a 2% discount.  Meanwhile, the NAV is nicely moving higher on the back of the equity recovery plus the discount has been closing.  We'll continue to hold waiting for the tender offer details. 

LOR's net assets are invested with a focus on the highest yielding equity securities selected using the relative value strategy of Lazard Asset Management LLC ("LAM") and generally are a portfolio of approximately 60 to 100 US and non-US equity securities, including American Depository Receipts ("ADRs"), of companies of any size consisting primarily of securities held by other portfolios managed by LAM, including investments in emerging markets. 

PGIM High Yield (ISD) is, along with NHF and ARDC, one of the more attractive buys right now.  The fund trades at a 13.6% discount to NAV, close to the one-year average.  The yield is a "juiced" 8.4% after the fund raised its distribution by shifting to a managed distribution policy while allowing for more of the junkier credits into the portfolio through an investment policy shift.  We're still holding the shares and may add on weakness.

RiverNorth Opportunistic Muni (RMI) is the latest addition to the Flexible Portfolio.  At a 5.85% discount, the fund is still relatively attractive though we have no basis for where the discount may end up.  I'll still be picking up shares in this one over the next week or two.  

Secure Act - End of Stretch IRA?

The likelihood that congress will pass the Secure Act appears to be on the increase.  If it passes, it would effectively kill the stretch IRA which basically allows non-spouse beneficiaries of an IRA to stretch out the distributions over a 10-year period and reduce the overall tax burden.  This could be a major future tax liability for the next generation as several trillion in IRA assets sets to move down to their children.

But the bill does have some benefits including:

  • Increase RMD age from 70.5 to 72

  • Allow Traditional IRA contributions past RMD age

  • Portability of Lifetime Income Options between plans

  • Treats home healthcare workers income as earned income for purposes of IRA contributions

  • For IRAs and Defined Contribution Plans, upon death of owner, the beneficiary of the IRA must fully distribute the plan balance within 10 years, unless the beneficiary is the surviving spouse, disabled or chronically ill, not more than 10 years younger than the owner, the child of the owner/employee who has not reached the age of majority

  • Allows older workers to continue to accrue benefits for a pension after the plan has been closed

  • Expands what 529 plans can pay for, including tech schools and up to $10K towards student loans

  • Penalty free IRA withdrawals for qualified birth or adoption expenses

  • Allows long term part time employees to participate in retirement plan

  • Up to $500 tax credit for small business who auto-enroll new employees

For those with complex estate plans, this could be a potential wrench in their cogs.

Stay tuned.  This is still in the formative stages but the end result means that the Roth IRA is far more valuable and conversions should be a significant part of the planning process for those nearing and in retirement.  We will have more updates on this including some analysis and information as the bill gets closer to passage.  But once April 15th passes, it may be wise to ping your CPA about it.  

We will also be putting out a full article on this in the near future- so keep an eye out for that.

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