By Daniel Shvartsman
The first half of 2019 saw a lot of green in the markets, as broader indices recovered from the brief bear market in the second half of 2018 and returned to new heights. Despite that, the wall of worry continued to grow, even if the specific concerns changed. Instead of a rising rate environment, expectations have shifted to a possible rate cut even with good job numbers. Geopolitical flashpoints have (re-)emerged in Venezuela, Iran, and in the ongoing China-US trade conflict. European economic growth appears to be slowing, and nobody's quite sure where we are in the US cycle. Oh, and another presidential election cycle is beginning.
So, what to make of this all? We decided to take the temperature of the markets with a midyear Marketplace Roundtable. We asked our Seeking Alpha Marketplace contributors - authors who run investing services and provide ideas and guidance to members about how to think about the markets or at least certain parts of it - to share their views on the current climate and how they're positioning as a result.
Over 55 authors participated in our survey. We've grouped their responses into several categories, ranging from tech to commodities, biotech to dividends and income investing. We're going to share their responses in those grouped categories over the coming week or so. Each discussion will have two common questions about the market as a whole, two sector-specific questions, and a round of current favorite ideas. We hope you enjoy the discussion and welcome you to join with comments on these issues or on any key points that didn't come up, or follow-up questions.
We conclude with a look at one of our most popular categories, dividend and income investing. We have a panel of 10 authors to weigh in on how the changing rate environment and the continuing bull market has affected their approach. The panel:
Fredrik Arnold: The volatility will continue. Nothing is resolved. Technological, financial, and healthcare disruptions loom for the next 5 years.
Richard Berger: The China trade war cease fire is temporary and will fail at some point with modest downward pressure from the current market and economy in general. Persian Gulf war expected to begin within 9 months, spiking oil and gold.
Richard Lejeune: No. I still see a lot of deeply depressed high yield issues in the shipping sector such as SB.PD, DSX.PB, and NMM. The BDI has rallied, and yet these issues remain depressed with well covered high yields. This shows that some stock prices still reflect major (and perhaps excessive) concerns about a trade war.
Stanford Chemist: This may sound surprising, but we generally do not worry much about market news. Our quantitative approach allows us to view opportunities in closed-end funds ("CEFs") and exchanged-traded funds ("ETFs") in an objective manner. During the Christmas meltdown, our metrics told us that CEFs discounts were the widest since the Great Recession, and we encouraged our members to buy deeply discounted CEFs (The Chemist's Closed-End Fund Report - January 2019: 'I Have Seen The End Of The World Come And Go Many Times. But I Am Still Here.' - many of these are up much more than 25%. Right now, CEF valuations are fairly valued to even slightly overvalued, so to answer the original question, yes, the doubt has been resolved at least in Mr. Market's mind!
The Dividend Guy: The market seems quite nervous and divided. Over the past two years, it seems there is a part of the market hoping their bearish thesis will finally come into play. They put emphasis on all negative news (trade war, debt level, yield curve, etc.) to prove their point. The other part of the market is full of bulls that aren’t done partying on one of the greatest rides on the stock market in decades. They will find any news to cheer them up. This gives place to very different mood swings, depending on which news cycle has the best song to sing. Expect more volatility.
The Fortune Teller: Absolutely not! First and foremost, not only that a trade agreement is far from being a done deal but there's still a high probability that the negotiations will reach an impasse. Secondly, it's important to remember that, in spite of no new tariffs being imposed (for now), the ongoing negative effect of the previous tariffs (that remain valid) is not going anywhere. Finally, most indicators - worldwide and in the US specifically - keep pointing out that the economy is slowing down. The only doubt which has been resolved is the Fed policy shifting back to easing. As for the rest - the doubts are even greater than before.
Rida Morwa: The market is riding off of positive economic activity and news on various fronts, but investors should keep in mind that we are at the last stages of the bull market. This is usually the part sharp gains are made in a relatively short period of time. I am bullish on equities as the years 2019 and 2020. Central bankers around the world are actively positioning themselves to prop up the current market and extend this long bull market. A recession is unlikely before the year 2021 or 2022. Still, we are advising our investors, members of "High Dividend Opportunities" to take a partial defensive position, with our portfolio being 40% allocated to fixed income, such as preferred stocks, bonds, and quality fixed income CEFs.
Arturo Neto: It's definitely an interesting time. I don't think the market doubt is resolved, but I believe consensus opinions on the next move in rates has a heightened sensitivity to economic data - at least more than normal. The President attacking the Fed publicly is unprecedented as well. I think the most recent market upswing was based on expectations of a Fed cut - which is quite different than the rate increase we expected not very long ago. A rate cut would give another boost to stocks, but now that the stock market has anticipated that, I'm not so sure the upside is so great from here. If the pendulum swings in the other direction, the pullback could be ugly.
Fredrik Arnold: Most large-cap dividend stocks are overbought, and their cost per dollar of dividend is rising. An Investor’s best hope is low-priced high-yield stocks whose free cash flow yields exceed dividend yields.
Richard Berger: Consumer staples and consumables have done very well as money flowed toward safety as expected. This will now ease off some, but I expect the trend to resume in the last quarter of 2019.
Richard Lejeune: Many high-yield issues sold off sharply in Q4 2018 due to fears of a recession and increasing interest rates. This created tremendous bargains for my Panick High Yield Report members. Many of those issues snapped back quickly in the first few months of 2019. Less high-yield bargains are currently available, but there are still some bargains in out of favor sectors such as midstream, shipping, and retail.
Stanford Chemist: The fall in interest rates, apparently unanticipated by the market but not wholly by us, has been a boon to our fixed income positions. Right now, valuations in CEFs focusing on longer-duration sectors such as utilities and preferreds seem overstretched. We are recommending to our members to be alert for signs of overvaluation in their holdings and rotate into cheaper alternatives to execute our "double compounding strategy".
The Dividend Guy: As a dividend growth investor, I’ve identified several great companies trading at lower levels toward the end of 2018. Most of them have surged, pushed by this important market swing. I’m now becoming cautious and require my new purchase to show strong and consistent growth for revenue, earnings, and dividend over the past 5 years. An absence of dividend growth while the economy is growing and debt is cheap is simply unacceptable.
The Fortune Teller: We keep shifting from growth to value, from small-caps to large-caps, and from lower to higher ratings. The leading theme is more safety and less risk. On the Wheel of FORTUNE, we cover all sectors, and we shifting allocations from sectors we like less, e.g. financials, to sectors we like more, e.g. energy (particularly midstream MLPs).
Rida Morwa: In the high yield space, we are being more proactive to ensure that dividends and distributions are covered. This has led to opportunities having a smaller window to capitalize on opportunities. Furthermore, we are required to add an extra level of diligence to ensure that our choices are recession resilient as we expect this will catch many investors off guard. This is why we have been actively highlighting preferred stocks, baby bonds and bonds – fixed income securities – as a means of maintaining high immediate income regardless of the economic cycle. This additional focus has brought a new layer of research and depth to our coverage.
Alpha Gen Capital: A significant amount has changed. For the last three years, we have been in a rising rate environment. Just think back to September of last year when the markets (and closed-end funds) were at peak valuations. At that time, the market was forecasting 3 Fed Funds rate HIKES over the subsequent twelve months. Fast-forward to today and the market is now forecasting 3 Fed Funds rate CUTS in the next twelve months. That is a radical shift in market sentiment when we are not in a recession. First quarter GDP was +3.1%, unemployment claims are still near record lows, consumer sentiment remains elevated, and most markets are at record highs. And yet, the market wants rate cuts.
Arturo Neto: I focus on income-producing investments, and the direction of interest rates has a specific effect on each type of the asset classes I focus on. For example, rising rates might negatively affect high dividend stocks like REITs and MLPs because the market's reaction is to shift towards safer investments as their yields become more attractive relative to REITs and MLPs. But we can't lose sight of the long-term fundamentals of these sectors - if rates rise, it's because economic growth is strong. What has changed in our universe is the expectations of the direction of interest rates. At the beginning of the year, rates were expected to rise - now, they are expected to be cut. When we get these extreme forecasts that really drive prices in the short term, we think it's a good time to find mispriced opportunities. We have become a bit more active in this environment - suggesting that our members take profits when valuations get stretched and buy aggressively when an attractive company's stock sells off.
Fredrik Arnold: I am advocating outstanding, proven dividend winners.
Richard Berger: Engineered Income Investing targets high quality dividend tickers to enter at value pricing, being paid to wait, then boost yield with covered calls with strikes to exit in value price bubbles. This strategy works well in all markets, and we will continue to generate superior double-digit yields while lowering (but never fully eliminating) market risk. Currently, the bias is towards cash secured puts on most targets.
Richard Lejeune: I'm especially bullish on the midstream sector. Oil prices have rallied, and we have increased Mideast tensions. US oil production just hit a new all-time record. Midstream provides the critical infrastructure so that the thriving U.S. economy is no longer dependent on shady Mideast governments for oil. Investors should appreciate this oversold sector more.
Stanford Chemist: We remain cautiously optimistic that the market environment will be benign for the rest of 2019 and going into 2020, which is perfect for our income generating approach. In terms of allocation, we remain well-diversified in our holdings in order to not to be "all in" or "all out" on any aspect. For example, we hold both senior loan CEFs, which are floating rate, and high-yield CEFs, which are fixed rate, in our portfolios, so we will do rather well no matter which way interest rate moves. Additionally, with a recession not being in the near horizon, we are comfortable with holding significant allocations to higher-yielding CLO equity funds, such as 16%-yielding Oxford Lane Capital Corp (OXLC) and 13%-yielding Eagle Point Credit Capital (ECC) to increase the overall yield of our portfolios. (What Are Collateralized Loan Obligations? (CLO/CLOs)(OXLC/ECC))
The Dividend Guy: I’ve always maintained a 100% equity portfolio since I started investing in 2003, and I will not change my strategy today. I finished 2018 in positive territories and didn’t modify anything in my dividend growth strategy. There is so much information available, so many different theories to follow (or get away from) that the only strategy I found that is working all the time is to keep my money invested in strong dividend growers. I don’t try to position my portfolio to capture outcome of a possible event. I leave that to meteorologists.
The Fortune Teller: The main question is how low the economic growth go to, i.e. will the US enter a recession or not? We don't rule out that the market may go through a correction, possibly even reaching a bear market, before the next US elections. Imagine the following, quite realistic, scenario: No trade agreement (negotiations break-up), US economic growth <1%, and the EPS of the S&P 500 sliding (compare to previous years). This is certainly not a scenario that has a low-enough probability, allowing investors to dismiss it too easily.
Rida Morwa: We are continuing to position our portfolio to capitalize on being ahead of the market by targeting recession resilient high yield stocks and funds. Preferred securities have an inverse relationship with common equity – when markets fall, they rise as investors flock to their relative safety. We have benefited already from being in place when other investors come flooding in as the market gets spooked from time to time. Furthermore, our emphasis on recession resilient choices has been key behind highlighting choices like Global Partners (GLP).
Alpha Gen Capital: We are taking a little risk off the table via our high yield bonds and leveraged loans. At the start of the year, we advocated getting into CEFs, both munis and non-investment grade (bonds and loans) in a big way. The discounts on the CEFs was very wide - the widest they had been since 2015. Additionally, the market was pricing credit risk assets as if defaults would approach 2008 levels when, in fact, they were near cycle lows.
That trade worked out though most of fixed income has done well so far in 2019. Going into the back half of the year, and especially at this point in the cycle, we want to be slightly more defensive. That doesn't mean going to cash but simply tilting the portfolio a bit towards sectors that haven't done as well so far in 2019, namely, mortgages. Munis also continue to be a big focal point for us, given the very favorable technicals (low supply, high demand) and the downside protection they can provide. While muni CEFs continue to trade tight to NAV, there is still a significant amount of value there.
Arturo Neto: My strategy is very fluid I don't really position for the back half of a calendar year, but rather position for the environment I see for the foreseeable future. I've been focused on emerging market bonds, both in hard and local currency. Many US investors aren't as familiar with EM bonds, but the fact is there are plenty of investment grade credits that pay higher yields than their US equivalents. There are other risks, obviously, but I think the risks in EM bonds are not what they were back in 1999. That said, this isn't an area I would recommend someone invest in individual securities. For starters, many of them have $200K minimums, which makes it hard for the average investor to invest in. I would also suggest an active fund not a passive fund - the EM market is one where you want an expert to help navigate.
Canadian Dividend Growth Investor: My core focus is on safe and growing dividends and buying great companies at good valuations. This focus doesn't change no matter what happens to interest rates. So, my dividend investing approach remains the same throughout cycles.
Fredrik Arnold: Whether tight money or easy money the watchword now is “safety.” Which equities or funds show the qualities required to weather the deluge or drought of ready cash?
Richard Berger: Dividend/Income portfolios is what Engineered Income Investing is all about. We employ a fully integrated strategy of valuation quality screening and monitoring of safe dividends, coupled with multiple methodology fair value analysis and appraisal tools. We then add the use of covered option writing to be paid to wait to enter at yields greater than the target dividend. Once holding a long share position, covered calls at strikes based on over value bubble are written to boost dividend cash and yields, self-liquidating the positions once they rise to bubbles. The year has been great for all segments, dividend growth, premium yields, and intrinsic gains. The ebbing rate hike pressure makes our approach even stronger going forward. Current coverage includes over 40 quality tickers. We also provide special opportunity covered option arbitraged ideas for high yield/low risk targeting known mergers and acquisitions. This approach uses the option leg to pay us cash premiums to do exactly what we plan to do anyway, exactly at the prices we plan to do them. Thus, in that limited sense, the option premiums are free money. The fully integrated generates 2X to 4X the income and yield compared to a simple retail investor doing the same thing, all while reducing risk. Because we are value based on entry/hold/exit targets, the strategy works in all markets and all phases of each individual target ticker.
Richard Lejeune: No. While interest rates have declined, the U.S. continues to run up massive deficits. Higher interest rates could return. At the Panick High Yield Report, I still favor fixed/floating rate preferred stocks to provide protection against an eventual increase in interest rates.
Stanford Chemist: Predicting interest rate moves is an extremely difficult business, and even the brightest pundits often get it wrong. Rather than worry about interest rate moves, we seek to diversify across both long duration (e.g. preferreds, munis) and short-duration (e.g. senior loans, CLOs) assets so that our portfolios will do rather well no matter which way interest rates move. With CEFs, we also aim to exploit volatility in premium/discount valuations when we feel that investors are too far on one side of the boat, which often has us taking a contrarian position. For example, when the bottom was falling out of fixed income CEF valuations last year amidst the interest scares, we were telling our members to buy them on the basis of their attractive valuations and valuable role that they play in smoothing out the volatility of a portfolio. Now, the pendulum has nearly swung entirely the other way (allowing us harvest substantial alpha from the discount contraction alone, not to mention the underlying NAV gains), we are advising members to be selective in their purchases and not be exuberantly bullish on longer-duration sectors such as utilities and preferreds CEFs which have become relatively expensive.
The Dividend Guy: Not really. My focus remains on dividend growth, not yield. A long-term investing strategy is likely to reduce stress and offer great returns (as long as you stick to it). I’m not a big fan of positioning my portfolio for a specific event. If you are wrong, you just missed a huge opportunity. However, I built a retirement portfolio showing a 4-5% yield and a steady dividend growth to cope with inflation. I think it’s the best protection against a potential recession. Companies showing very high yield may become at great risk if the economy plummets.
The Fortune Teller: One of the biggest mistakes many investors seem to be doing these days is to assume that the rising tide (lower rates in this case) will lift all boats (rate-sensitive instruments). That line of thinking may get back as a boomerang hitting the faces of many investors who are now chasing high yields. Lower rates, as a result of an economic slowdown, may come along with widening spreads (of securities with lower quality/rating) that theoretically can eliminate the effect of lower rates completely. Furthermore, although short-term yields will follow the Fed Funds, it's not at all certain that long-term yields will follow through too. There's a risk that the high level of debt (old and new*), combined with an economic slowdown, will see investors fleeing US debt, pushing long-term yields higher, while most investors assume they are heading lower. Chasing yields at this point, due to the assumption that lower rates = higher prices, is certainly not something we suggest these days. *According to some expectations, US debt will rise ~$600B over the 6-12 month period, following an expected rise to the debt ceiling (later on this year).
Rida Morwa: This is so true, investors have been living in the longest bull market. An entire group of investors have only learned to adjust to rising rates and a highly valued market. We have actively covered our outlook on interest rates – forecasting cuts and a stall rate environment while the market expected them to rise further. This belief that accommodation is coming has propelled our deeper analysis and investment in preferred securities. Locking in a high yield now, with a long time frame until being called will ensure that you have a secured income stream. It also allows the common equity to work as an extra layer of insulation from potential dividend cuts. We’ve also moved into less understood waters, for most investors, like CLO assets – Oxford Lane (OXLC) and Eagle Point (ECC) – which strongly outperformed the market at its worst by over 23%. Fixed income investments now are a must to ensure strong income during a rate cut environment and to provide capital to pick up fantastic opportunities when they become oversold.
Alpha Gen Capital: In the fixed income closed-end fund space, we need to be careful of rising rate environments as it can hurt you two ways: the first is rising rates typically reduce bond prices. That is well known. The second is the rising leverage costs on the funds themselves. That reduces the earnings spread (the amount of income produced minus interest expense costs). This is what has led to the multitude of distribution cuts in the last two years, especially on the municipal bond side. Lower interest rates help reduce leverage costs and improve NAV returns. While this won't last forever, the overhang of high interest rates has been removed helping to improve the sentiment among closed-end fund investors.
Arturo Neto: Yes. In a rising rate environment, REITs tend to sell off along with other dividend paying stocks even though a rising rate environment is indicative of rising real estate prices. It's a typical reaction that really doesn't make sense especially when you look at historical data that reveals REITs outperform stocks over the long-term during rising rates. When rates were expected to rise, we became cautious about the potential REIT pullback. Not because we became bearish but rather, why not reduce positions in the short-term and buy back in when prices pull back? With the rate outlook a bit more neutral to dovish, I'm not so concerned about a broad REIT pullback in the short term. However, I am a bit worried about valuations. REIT valuations are high. They may not be stretched, but they certainly aren't cheap any more. If we get a big rebalancing or a reversion to the mean - of sorts - the price pullback I would have expected due to rate hikes may occur due to valuations.
Canadian Dividend Growth Investor: Brookfield Property Partners L.P. (BPY) [TSX:BPY.UN] remains one of my favourite ideas that sits in my retirement account and gets its cash distribution reinvested back into the stock. It offers a yield of close to 7%, which is sustainable by a global portfolio of quality real estate assets and its capital recycling strategy. Some investors don't like that its core assets (80% of the portfolio) are in retail and office assets. However, the 2 core portfolios maintain very high occupancy rates of about 95% and 93%, respectively, and the assets are set to generate higher rent when leases expire.
Fredrik Arnold: Sirius XM Holdings Inc. (SIRI). It’s cheap, it has a monopoly, and Buffett owns it. Its his only holding that isn’t overbought.
Richard Berger: Writing Cash Secured puts in the $6 to $7 strike range on Sprint (S) in the dragged-out merger with T-Mobile US (TMUS). With FCC approval finding the deal in the public interest, it qualifies as exempt from the anti-trust laws. This makes the DoJ and State lawsuits virtually impossible to prevail, and so, they simply delay the final deal. So long as the deal does ultimately complete, Sprint value is about $8.25 in the merger/acquisition. The longer it drags out, the more repeats on writing the puts, generating annual yields in the 25% to 50% range.
Richard Lejeune: I'll give you 3 favorites quickly. Martin Midstream Partners (MMLP) and Summit Midstream Partners (SMLP) are huge midstream bargains. Both stocks have crashed due to dividend cuts. Both yield close to 15%. Both dividends are now well covered. I also like MLPQ to play a rally in the midstream sector. It has no K-1, and the price tracks a basket of midstream issues. MLPQ is 2X leveraged, so this is not an issue I would recommend for widows and orphans.
Stanford Chemist: We really like Eaton Vance Tax-Managed Buy-Write Strategy Fund (EXD) as a core equity fund. The fund has call option coverage on ~100% of its portfolio, making it a relatively defensive fund. The fund dynamically allocates between the S&P 500 and NASDAQ as its benchmarks, so it has a tilt towards the strong-performing tech sector. Importantly, the fund was completely overhauled in February of this year (it was previously known as the Eaton Vance Tax-Advantaged Bond & Option Strategies Fund and had terrible performance), and many investors may not yet realize that this CEF now employs a similar strategy to the rest of Eaton Vance's option income funds that are trading at much higher valuations. We anticipate that EXD's -7.5% discount has significant room for contraction, even though it is already up significantly from its -14% discount when we first purchased it for our members. It is currently the largest equity position in our Taxable Income portfolio, which is geared towards maximizing after-tax returns.
The Dividend Guy: I know a lot of dividend investors will talk about AbbVie (ABBV), so I will pass on this one (while it’s on my buy list). I would go with Disney (DIS) as investors don’t seem to get the full potential of their streaming services. DIS already dominated the box office for several years, and their recent acquisition of Fox assets will give them enough great content to go all-in with streaming. DIS main strengths lie in its content and how it uses it for cross-selling across multiple channels. Disney has proven over and over its ability to acquire content sources and create money-making machines with them. Think of how much Lucas Film would sell for now (bought at $4B), same for Marvel and Pixar.
The Fortune Teller: Healthcare is a sector that everybody seems to hate nowadays, mainly due to falling drug prices, as well for being beaten-up by regulators and politicians. While these risks are valid - and likely to remain so till the US elections (at the very earliest) - valuations of many pharma behemoths are attractive. M&A activity is peaking up (e.g. ABBV-AGN, BMY-CELG, PFE-ARRY) and is likely to accelerate further. We see some great opportunities here, and although it might take at least 1.5-2 years for some of these opportunities to that value to bear fruits, we have the patience.
Rida Morwa: Currently, we’re extremely bullish on Annaly (NLY). As a mortgage REIT, it is designed to benefit when the market is falling. Rising rates and stagnate rates are the worst conditions for their portfolio. Many mREITs have positioned themselves to benefit from rising rates via ARMs and MSRs, but these items make them targets for underperformance when rates fall. Conversely, NLY’s historical performance during recessions is outstanding, large price increases, and dividend increases along with it. Investors selling NLY now are selling at its worst, while the next upswing is right around the corner. Plus, a large 11% yield pays you while you wait.
Arturo Neto: mREITs - The yield curve has either been extremely flat or inverted at times recently. That is usually not good for mREITs because they borrow on the short-end and lend on the long-end. If those rates are similar or inverted, the spread is narrow, and the mREIT is forced to leverage to generate a desired profit. However, with a flat or inverted yield curve, expectations are that short term rates will decline while long-term rates will rise - or some combination that would result in a steeper yield curve. So, on a forward-looking basis, this could be the bottom for mREITs - at least as far as how the yield curve affects them. Many of them have also delevered considerably recently, so they have plenty of flexibility to take advantage of wider spreads too.
Thanks to our panel for participating! You can check out their profiles and services at these links:
That's it for our midyear Roundtable. We'll run this back at the year end and see how things went in the interim. If you'd like to review any of the other editions, here are the prior rounds:
Any thoughts on dividend investing as rate expectations drop? Any thoughts on these ideas? Please let us know below. And thanks for reading!
This article was written by
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Canadian Dividend Growth Investor is long BPY.UN and CAT.
Richard Berger currently has cash secured puts running on Sprint (S) at $7 and $6 strikes for 1 to 3 months out.
Richard Lejeune is long NMM, SB.PD, MLPQ, MMLP, SMLP and DSX.PB.
Stanford Chemist is long OXLC, ECC, and EXD.
The Dividend Guy is long ABBV and DIS.
The Fortune Teller is Long ABBV and CELG, and short ABBV 01/17/2020 80.00 PUT and BMY 01/17/2020 45.00 PUT.
Rida Morwa is Long NLY, OXLC, ECC, GLP, and GLP.PA.
Arturo Neto is long MPLX and ET.