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What Goes Up Must Come Down, Right?

Sep. 11, 2021 2:22 AM ET
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A rising market doesn't always mean that the market can't keep rising. This was one point brought up by Dividend Seeking in a recent article he has published to members of the CEF/ETF Income Laboratory. This was just one topic touched on, the other concerns for some headwinds that we should keep in mind include; Covid, infrastructure plan, debt ceiling, labor force and taxes.

What Goes Up Must Come Down, Right? Maybe

To begin, I want to touch on the why behind why we should consider some factors that may push stocks lower. While it may sound counter-intuitive, the market's steady rise has got me feeling concerned about a potential correction. Yes, the bullish behavior in stocks is certainly a good thing, and it could certainly continue for the foreseeable future but, as investors, we have to plan for the opposite scenario as well.

To understand my concern, let us look at how we got here. For the past seven months, U.S. stocks have posted almost uninterrupted gains, as measured by all three of the major indices:

Source: Google Finance

As you can see, except for the Nasdaq's blip in April and May, stocks have been on a tremendous run. In fact, going in to 2021, many pundits thought we would be lucky to see double-digit returns. Now, we four months in the year to go, we are sitting near a 23% return for the S&P 500 - pretty amazing stuff.

That is the good news. The future outlook is a bit more mixed. Fortunately, there is a precedent for stocks to keep rising almost seven positive months in a row. The bad news is, there is also a precedent for stocks to fall after such an occurrence. Over time, the gains following a similar win streak have been uneven, but most recently stocks have see little or no gains. While 2017 saw strong gains following a seven month win streak, the instances preceding it in the prior two decades show an almost even split of winners and losers:

Source: Yahoo Finance

For me, this is something to keep in mind. The market's run has been incredible, and history suggests further gains are possible. But the likelihood of more gains is ambiguous, it seems very likely if we consider market periods back in the 50's and 80's. From 1991 on, we see only a few years of meaningful gains are a seven month stretch. Of course, history does not always repeat, but it does indicate the probability of continuous gains beyond seven months is nowhere near a certainty.

As we can see, it isn't always clear on which way the market goes after such runs. That being said, the Income Lab can help maneuver in any environment. In fact, if some volatility would pick up, our double-compounding strategy can work even better.

The "compounding income on steroids" methodology enables one to grow their share count without DRIPing. So in effect, you can potentially get a double compounding from CEF rotation plus dividend reinvestment. For investors who need to withdraw their dividends for living expenses, this method can also allow you to grow the income stream to keep up with inflation, even without having to reinvest all of the distributions.

The nice thing about this strategy is that it can be easily fine-tuned to fit the style of both active and passive investors. Even so, many conservative investors still balk at the first mention of "trading" or "arbitrage" or "rotation". They may ask,

"Why sell a fund that has been paying me a steady dividend for X years? Whether the fund is overvalued or undervalued does not affect the stability of the income stream."

My response is: yes, that's right. But we can do better than that!

Our method is simply a strategy that is OVERLAID on top of an existing income strategy and DOES NOT replace it. Even a few trades a year can make a huge difference to the bottom line of a conservative income portfolio!

Just ask yourself this question: if I came up to you and offered you a FREE increase of 5% of your existing shares of a particular CEF, would you say yes or no? If your answer is yes, take the dive today and let us help you!


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Why CEFs or ETFs?

Closed-End Funds

CEFs offer higher juiced-up distributions. We call them distributions because this more correctly classifies them. The source of "dividends" comes from more than just income, it can come from income, capital gains or a return of capital. Return of capital isn't always bad either, as we have delved into in the past.

Another reason CEFs can offer more monthly or quarterly income is for the fact that they can use more complex strategies. This can include the utilization of leverage or options strategies. Both of these strategies can potentially enhance returns, or even potentially mitigate drawdowns - in the case of options being used. These strategies do involve a more actively managed portfolio. This involves investment managers running the fund on a day-to-day basis. That also increases costs for the funds to operate, increasing their expense ratios.

This is exactly where CEFs can fill a role in one's portfolio; primarily as a way to juice up portfolio yields and income. The average distribution rate for all CEFs as of July 15th, 2021 is 6.14% (using CEFConnect's data.) This is much higher than we would see for individual stocks and even higher than the typical ETF.

Of course, there are dangers, just like any other investment vehicle. In the case of CEFs, two specific dangers exist. The use of leverage in a downturn can amplify the drawdowns in sharp sell-offs. This is exactly what we see time and time again. Another "danger" in CEFs is the fact that they can trade at premiums and discounts. This isn't so much of a danger as it is an opportunity for vigilant investors to get some excellent entry prices.

Exchange-Traded Funds

With almost 7000 ETFs worldwide in 2019, there are certainly a few out there to meet an investor's specific and unique needs. These are generally a passive way to invest, although there are more and more active ETFs coming to market, it seems. This passive nature can cause expenses to drop significantly. However, the passive nature of these investments can also result in some strange and unfortunate manners. This can happen when a portfolio rebalances at the wrong time.

This isn't to suggest that ETFs don't deserve a place in a portfolio. One just needs to be aware that they are essentially on "auto" mode and will carry out their investment policy, regardless of negative consequences. They absolutely do fit a place in an investor's portfolio.

Some ETFs do have extra juiced-up yields, like CEFs. Although typically, we see the vast majority of ETFs only pay dividends (i.e., only the income received and passed through). I say this as I am on the hunt for adding even more ETFs to my mixture of investments. I hold several dividend growth stocks too.

With all of this being said, ETFs ultimately can fit any objective you need them to, whereas CEFs are typically more limited to income-focused investors, though there are always exceptions to everything. There are ETFs for growth, capital preservation and income. There are even those that would fit in the speculation category.


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Stanford Chemist, Nick Ackerman, Juan de la Hoz and Dividend Seeker

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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