Joe Eqcome's  Instablog

CEF Weekly Review: The 13 closed end fund (CEF) types on average posted a 0.7% increase for the week ending 11/27/09. On an aggregate, unweighted basis, the weekly average price change for the 496 CEFs also increased 0.7%.

The weighted 49 CEFs comprising the Claymore CEF Index registered an average advance of 1.5% for the week. The S&P 500, as measured by the SPDR S&P 500 ETF (SPY), was up 0.1% on very light volume. The holiday shortened week included both a “gap up” (Tuesday) and “gap down” (Friday).

(Click Here for YTD CEF Performance. The table is based on a 274 CEF sample size as all the data fields are not available for the CEF universe.)
The Eqcome CEF Fear Index registered a positive reading with weekly price changes exceeding changes in NAV by 0.2% (0.65%-0.45%, respectively). The CBOE Volatility Index (VIX), which typically moves inversely with the stock market, trended downward for most of the week; however, on Friday it spiked 20.8% on the news that the Dubai government was not coming to the rescue of its flagship holding company, Dubai World. Dubai World delayed debt payments on $3.5 billion of Islamic bonds due for repayment in December. Despite the VIX’s Friday spike, it ended the week up 11.5%.

So, we got through earnings season OK.

Next Major Signpost: The next major issue confronting investors will likely be the impact of the government’s fiscal and monetary credit expansion on the economy. Will such a credit expansion lead to an increase or acceleration of inflation? What will the impact of inflation have on equity valuations?

Inflation’s Impact on Stock Market Valuation: Below is a chart of the “earnings yield” (P/E ratio inverted) of the S&P 500 versus the CPI –U (All Urban Consumers) index. The S&P 500 earnings yield is calculated by dividing the year-end EPS of the S&P 500 by its year-end index value.[i]

The graph above shows a positive relationship between the YOY change in the CPI and the S&P 500’s earnings yield at year-end. This means that as inflation increases so does the earnings yields of the S&P 500. Since the P/E is the reciprocal of the earnings yield, an increase in inflation would lower the P/E and create a lower relative valuation for the S&P 500.

This would make sense: as inflation increases investors would require a higher earnings yield to generate a “real return” (nominal return minus inflation).

CEF Weekly Review: The 13 closed end fund (CEF) types on average nudged into positive territory posting a 0.2% increase for the week ending 11/20/09. On an aggregate, unweighted basis, the weekly average price change for the 496 CEFs remained unchanged.

The weighted 49 CEFs comprising the Claymore CEF Index registered an average advance of 0.2% for the week; First Trust CEF Composite Index was off 0.1%. The S&P 500, as measured by the SPDR S&P 500 ETF (SPY), was off 0.2% on light volume.

(Click Here for YTD CEF Performance. The table is based on a 272 CEF sample size as all the data fields are not available for the CEF universe.)

The Eqcome CEF Fear Index was essentially unchanged with weekly price changes and NAV changes at the flat-line. The CBOE Volatility Index (VIX), which typically moves inversely with the stock market, declined 0.5% for the week even in the face of a market swoon on Thursday. The VIX’s pacify in the face of investors ricocheting in-and-out of the “risk trade” is disconcerting.  

CEF Weekly Fund Type Performance: CEF fund type performance for the week took on some defensive characteristics. Fixed-income CEFs performed better than equity-oriented funds. Leading the procession was WrldIncFnds that was up on average 1.4%. This may have been a function of President Obama’s trip to Asia coupled with a conservative investment outlook. WrldIncFnds were followed by InvGrdBndFnds and OtherFnds, both up 1.3%.

GenEqFnds were off 1.5% as the week’s worst performer. This was a function of two Cornerstone Advisors’ CEFs share price significantly dropping on distribution reductions. (See negative PrcNAVSprd section below)

CEF Spread Changes: Changes in PrcNAVSprds generally follow the trend of price movement. This is typically the case when markets generate meaningful price changes. WrldIncFnds, which was the week’s best performer, registered an increase in NAV over share price change. This was also true of the USMrtgBndFnds. Most of the equity-oriented CEFs saw their average price decline more than related NAVs.

CEF Winners and Losers: Two of the North Carolina muni funds registered some of the greatest positive PrcNAVSprds. Nuveen NC Muni Fund (NII) and Nuveen NC Div Adv Fund recorded positive PrcNAVSprd of 4.9% (5.3%-0.4%) and 4.6% (4.9%-0.3%), respectively. A upgrade by Fitch, the rating agency, of some North Carolina hospital bonds, to “BB+” from “BB-“ with a stable outlook, could have encouraged investors that more upgrades could be in store for NC munis.

(A positive PrcNAVSprd can be viewed as a negative, subject to other metrics, as it would indicate the stock price has increased greater than the NAV. In theory, CEF prices and NAVs should move in a more tandem fashion.)

This week’s extreme PrcNAVSprds are coming in pairs. Two of the CEFs with the greatest negative PrcNAVSprd during the week were associated with the same investment advisor: Cornerstone Advisors, Inc. Both Cornerstone Strategic Value Fund (CLM) and Cornerstone Total Return Fund (CRF) recorded negative PrcNAVSprds: 15.3% and 13.6%, respectively, as a result of share price declines. After the close last Friday (11/13), both CLM and CRF reported a 20% and 23% reduction in their monthly distribution for the first three months of ’10, respectively. A substantial portion of those distributions is a return of capital.

Market Perspective Prior to the most recent stock market peak in Oct ’07, an investor would have made money even if he/she were unfortunate enough to have purchased the DJIA at any of its peaks since 1900. The key is living long enough. So, being an unblinking optimist was a helpful personal affliction during the previous century. That may no longer be true.

As Winston Churchill once remarked, “A hopeful disposition is not the sole qualification to be a prophet.” Maybe, it’s no longer the sole qualification for successful investing. (For the purpose of conservation of space and to keep the focus on CEFs, this week’s “Market Perspective” is available by hyperlink: “Stock Market Optimist Revisited”.)  

(Click here for next week’s economic calendar; click here for earnings announcements and estimates.)

ETFs: (Click Here for ETF YTD sector performance.)            

Insider Trading: The Horejsi Group continued to pile into Boulder Growth & Income Fund (BIF) in a big way adding an additional $1.2 million in stock market value during the past week.  Month-to-date it brings the total acquisition amount to $2.0 million.

Over the past year, Horejsi Group has acquired 2,387,567 shares of BIF at an average cost of $4.35 per share for a total outlay of $10.65 million dollars representing 9.4% of the outstanding shares. Its cumulative holding of BIF is 5.5 million shares or 21.6% of all outstanding shares.

The Horejsi Group as both the largest shareholder and owner of its investment manager has a delicate situation regarding the year-end review of its previous year’s suspended distribution policy. To the extent a return-of-capital distribution is declared, it would partially reimburse the group for its most recent share acquisitions by the 15% average discount that it paid for the shares relative to its NAV. Alternatively, any decline in NAV would diminish its investment management fees.    

The Horejsi Group also continued buying shares of Denali Fund (DNY) where it is also an insider and advisor. The Group acquired an additional $60,114 in market value raising their total for the month to $193.919. Horejsi Group has effectively taken DNY private as it owns approximately two-thirds of the shares outstanding.

This new burst of buying of BIF and DNY would be a function of monies the Horejsi Group will likely receive as a result of their significant holdings in two real estate CEFs, DWS RREEF Real Estate Fund (SRQ) and DWS RREEF Real Estate II (SRO), that are planning to liquidate. Will this newly freed money go to acquiring additional shares of BIF, DNY or BTF?

BofA/Merrill Lynch continues to liquidate its holdings in several CEFs this week. Such holdings included: NPP, MZF, NQJ and EAD.

Mark Lieb, characterized as “other” in the “Form 4” filings, acquired 12,000 shares initial position at $6.55 per share in Nuveen Quality Preferred Income Fund 3 (JHP). It was an “out of the blue” purchase as the last insider purchase was made December of last year.

Stephen A. Walsh, a Deputy CIO of the Sub-advisor, purchased 3,700 shares at 10.51 per share bringing his total holdings to 11,700 shares in Western Asset Global High Income Fund (EHI). He was an earlier buyer this year.

Robert F. Birch, a director of Helios Strategic Mortgage Income Fund (HSM), added 2,374 shares to his position at $5.75 per share. Bernard J. Korman, a director of New American High Income Fund (HYB) has been a steady buyer of shares adding small positions during the month (option exercise?) to bring his total share ownership to 194,661.

CEF Distribution Announcements This Week: The following is a link to a table of CEF distribution announcements this week as well as previous weeks’ with yet expired ex-dividend dates. The list is not intended to be inclusive. The report is produced Thursday evening/Friday mornings and is posted on Joe Eqcome website to enable investors a look at those CEFs that might go ex-dividend the following Monday. The report is again updated over the weekend. (Click Here for Weekly CEF Distribution Announcements)

CEF Focus for the Week: The focus stock of the week is Boulder Growth & Income Fund (BIF). The insiders continue to be stepping up their purchases which have the potential to accelerate due to a liquidity event for their largest shareholder and the possibility of a year-end distribution (certainly, no guarantee on either). BIF is trading at a 15.3% discount and is not currently making distributions on its common stock. Additionally, its largest holding is Berkshire Hathaway Inc., A (23.8%). A resumption of a distribution policy would give this stock a “kick”. (See related report entitled: Insider Buying at BIF: A Case of Manipulation or Hallucination?

Consider it food for discussion.

Joe Eqcome (Disclosures: SPY & GLD and a diverse CEF portfolio including BIF)

Having the privilege to have met Sir John Templeton, the founder of The Templeton Funds, I was stuck not only by his crushing intellect but also by his sense of optimism regarding investing. Warren Buffett, a fellow optimist, who upon acquiring Burlington Northern Santa Fe Corp. (BNI) for $26.3 billion said, “It was a bet on America”.  

Optimistic Investing: Being an unblinking optimist has been a helpful personal affliction for successful investing post-WWII. The S&P 500 is up 65 times since 1950. On a weekly basis it has advanced 56% of the time. Prior to the most recent stock market peak in Oct ’07, you would have made money even if you were unfortunate enough to have purchased the DJIA at any of its peaks since 1900 (see accompanying chart). It was the equivalent of throwing darts at a dartboard with nothing but a “bull’s eye” on it.

Investors’ Buying with Conviction: Earlier in this period investors’ optimism was expressed in the fact that “up-volume” (a positive percentage change in average weekly share volume) was associated with a positive weekly price change for the S&P 500 index. Moreover, since 1950, the S&P 500 advanced 1.4 times on positive volume versus declining volume and price.

So, for the bulk of this period, investors were enthusiastic buyers and reluctant sellers of stocks. However, on that metric, investors may have a lot less to be optimistic about going forward in the volume/price relationship.

Less to be Happy About: The S&P 500’s weekly advancement on “up-volume” has declined from an average of 31.9% for the period to just 25.1% for the current decade. Optimist directional volume (up-volume on S&P advances, down volume on S&P declines) has steadily eroded from 58.1% in the ‘50’s to 46.8% in the ‘00’s.

More Bad News: On another discouraging note, the correlation of weekly percentage change in volume versus the percentage change in the index has drifted negative in the current decade. As of late, there is a greater percentage of higher volume associated with negative price changes.

The chart below tracks the 3 week moving average of the percentage change in the S&P 500 volume (inverted) with the change in the S&P 500 index since the stock market peak in 2007. The chart demonstrates higher volume on lower index value.
Not Your Father’s Stock Market: Some of this can be explained by the explosion of trading volume (average weekly volume is up 1,549 times since early 1950 levels), greater opportunity to short stocks, more complex trading strategies that employ hedging, option trading, the emergence of the hedge funds and the growth of offshore stock exchanges providing an alternative to domestic stock markets.

The other part of this explanation may be decreasing investor optimism regarding the prospects for the US economy and its equity markets. The former may just be the tools that reflect our waning conviction regarding US economic prowess.

CEF Weekly Review: The 13 closed end fund (CEF) types on average squeezed into positive territory posting a 0.1% increase for the week ending 11/13/09. On an aggregate, unweighted basis, the weekly average price change for the 496 CEFs straddled the flat line as it declined by 0.1%.

The weighted 49 CEFs comprising the Claymore CEF Index registered an average advance of 1.7% for the week. The S&P 500, as measured by the SPDR S&P 500 ETF (SPY), extended last week’s 3.4% advance by tacking on an additional 2.3%.

(Click Here for YTD CEF Performance. The table is based on a 273 CEF sample size as all the data fields are not available for the CEF universe.)

Adams Express Company (ADX) is a closed-end fund (CEF) that has traded at a persistent discount to its NAV. (For background on the case, see the previous report dated 3/2/09 entitled: “The Case for Tender, Liquidation or Conversion of ADX”.)

The unfortunate aspect of ADX’s persistent discount is the managers of this internally managed CEF have done a reasonably good job of meeting its benchmark returns.

So, this article is not an attack on the management’s investment prowess. It is more of a commentary on two issues: 1) inaction on the part of the independent directors in the face of viable alternatives to maximize shareholders’ value; 2) the possibility that a closed-end fund (CEF) may be a sub-optimal vehicle for ADX.

Why ADX Converting to an ETF is a Win/Win Situation: Simplify put, an ETF is an open-end investment company that is actively traded throughout the day on major stock exchanges; much like a stock of a publicly-traded company, ex., IBM. The important difference between a CEF and an ETF is that an ETF trades at vastly narrower discounts to its NAV—the objective is to trade at par. (I will spare readers the mechanics of this task.)

Emergence of Actively Managed ETFs: While ETFs have historically been designed to track rule-based indices (SPDR S&P 500 ETF: SPY), early last year the SEC approved the launch of actively managed ETFs (“AcETFs”). Invesco PowerShares, Inc. has been one of the most active having launched four active managed ETFs. There are a number of other advisors that have launched AcETFs: Grail Advisors, LLC, American Beacon Advisors and State Street Corp, to name a few.

Here are the reasons why converting ADX to an AcETF makes sense:

1.   The board of ADX will be creating $165 shareholders’ value as the discount is eliminated. This is the equivalent of $2.00 a share, or an immediate return to shareholders of 20% on current share price.

2.   ADX would not be liquidated. It would continue as a “going concern.” Management would remain in-place and continue to operate the company with respect to its portfolio objectives.

3.   ADX would also get a “first mover” advantage. AcETFs have gotten off to a slow start. Many of the new AcETFs have been started from scratch. The average new AcETF has less than $10 million in net assets. By ADX converting to an AcETF, with net assets of $1.1 billion, it would be the “800 pound gorilla” in this space. It would preempt others from angling for that actively managed ETF large cap niche.

4.   ADX’s expense ratio (0.48%) is significantly below that of the other actively managed ETFs (0.70%), so it would have a significant marketing advantage.