He uses band saw to cut the wood
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Let’s talk about last Friday’s market crash and the shaky markets we’ve seen since then. Because in times like these, the dividends from our closed-end funds (CEF) are an important tool to get us through the crisis.
As experienced CEF investors know, the outstanding strength of these 500 or so funds lies in their high payouts, which today average around 7%. Payouts like this can bridge us until we get to the other side of a market meltdown.
What is our strategy? At CEF Insider, as with all of our Contrarian Outlook Premium newsletters, we remain light-footed, ready to sell ailing holdings quickly and capture dividend payers at bargain prices as they appear.
Our dividends also put us ahead of those who just buy the popular names of the S&P 500 and are stuck: Most of our picks have returned 6% or more on purchase, and overall payouts have actually increased, some due to the big annual special dividends we receive from the Adams Diversified Equity Fund (ADX).
And 15 of our 23 CEF holdings pay dividends each month, which aligns with our bills. This is a plus that reduces our need to sell in the whipssaw markets that we have seen over the past two years.
I know this can seem like cold comfort when we see our accounts slide into the red on a daily basis, but remember that corrections like these are part of the cycle – they shake out speculation and set the stage for market action run higher next (note that lagging tech stocks and crypto — bitcoin is down 43% since its November peak — have taken particularly staggering blows this time around).
So what lies ahead? The truth is that we are in unprecedented times and volatility is likely to get worse before it gets better. But there are indicators (including one from the Federal Reserve) that give us an idea of when the market might turn.
Before we get to that, let’s look at where we are now. The NASDAQ has fallen almost as much as it did during the March 2020 drop (hard as it is to believe), with a 20% plunge north from its last high through April 30, while the S&P 500 and Dow Jones have about three quarters of the way there, from their last peaks:
Current lows and COVID lows
CEF Insider
Now let’s compare the economy of today to the economy of yesteryear: Two years ago, COVID-19 shut down the world with no vaccines in sight.
Today? Yes, first-quarter GDP contracted 1.4% on an annualized basis, but that was mostly due to the US trade deficit, which is subtracted from the bottom line figure. Consumer spending is still healthy, up 2.7%, and the composite earnings growth rate for the first quarter is 7.1%, according to FactSet, which is also a decent performance (this number combines earnings from companies that reported have, with estimates on those who haven’t already too). Businesses also joined in, increasing spending on equipment by 15.3%.
With that in mind, there’s no reason to think stocks would fall as low as they did during the COVID-19 crash. And in the unlikely event that that is the case, the market would be clearly oversold.
Assess climbs that are likely to be sharp—then slow down quickly
That’s all well and good, but we haven’t talked about the key player in all of this, the Fed, which after fueling stocks with rate cuts and quantitative easing is now reversing both to clean up the inflationary mess it has created a 50 basis point hike announced yesterday and futures markets are now expecting:
rate odds
CME group
Above we see market expectations for the Fed’s interest rate target through early November, six months from now at the time of this writing. And we can see that November’s forecast shows rates between 2.75% and 3%, which roughly corresponds to the peak of the last rate hike cycle, which ended in 2018.
That’s good news, because the 2018 peak is probably a reasonable indicator of the current rate hike cycle, especially given that debt — including consumer, sovereign, and corporate debt — is much higher today, amplifying the impact of any rate hike.
In other words, if the Fed reaches “normal” interest rate levels (which would be around 2.5% if you look at the last few decades) and the economy responds, which seems likely, the central bank could ease up on hiking tariffs. That in turn would mean that towards the end of 2022 and 2023 we will be talking about rates stabilizing or even falling. Both scenarios bode well for our CEFs, particularly funds that hold liquid technology companies that have been unfairly dragged down by their speculative cousins.
Michael Foster is the Lead Research Analyst for Contrarian Outlook. For more great income ideas, click here for our latest report, Indestructible Income: 5 Bargain Funds With Safe 7.5% Dividends.
Disclosure: none
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