2014 The Case For 'Reverse Rotation' Into Bond CEFs

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2014: The Case For 'Reverse Rotation' Into Bond CEFs
Dec. 24, 2013 3:13 PM ET | by: Arsene Lupin 21 comments |
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2014: The Case For 'Reverse Rotation' Into Bond CEFs - Seeking Alpha http://seekingalpha.com/article/1915381-2014-the-case-for-reverse-rotation-into-bond-cefs
1 of 11 1/11/2014 1:27 PM
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
I'll start with a confession of bias. I subscribe to the theory that red-blooded investors such as yours truly go for stocks, and that bonds are best left
to the portfolio of one's mother-in-law. But changing times require re-examining one's axioms. Given the euphoria around stocks and the gloom
around bonds, now is a good time for said re-examination. And my conclusion is, on a relative valuation, basis bonds offer not only a better
risk-reward, but possibly a better absolute reward. I would hasten to point out that I am talking specifically about closed end bond funds, where
you are playing both the income and the end-of-year NAV discounts. Below are some of my arguments for the bond stock reverse rotation.
How Euphoric Are We? The answer, according the Citigroup's Tobias Levkovich, is high, but with the potential to get to excessive. Nevertheless,
he notes that readings at this level (see figure below) indicate the market may retreat with an 83% historical probability of losses in the next 12
months. So if you are adept at spotting greater fools, you can certainly play stocks, but risk-reward is not on your side.
(click to enlarge)
We are on the wrong side of growth. The same Zero Hedge article alluded to in the point above also points to a normalized earnings chart. This
chart (below) shows that EPS growth is trending in the wrong direction, and cannot justify the elevated P/E of the current market in the months
that follow.
1.
2 of 11 1/11/2014 1:27 PM
(click to enlarge)
Bond Closed End Funds Trading with Doomsday Discounts. As pointed out by multiple sources, such as the figure below and this article from
Forbes, bonds have been vilified beyond what they deserve. On a relative valuation basis, as well as a historical discount basis, they are well worth
the look.
(click to enlarge)
3 of 11 1/11/2014 1:27 PM
(click to enlarge)
Bonds are the Turbo-Charged Tricycle. Bond Closed-End Funds give you a three-pronged vehicle for total returns - dividend, the lifting of steep
year-end discounts, and the upside from a potential scenario of an earnings recession. A recent Barron's article offers a collation of investment
choices from various hedge fund sources. The Barron's article makes a case for all manner of income vehicles (including Preferred Stocks) but
specifically calls out Municipal Bonds as worthy of a look.
In summation, investing in optical networks, robotics and social media is more fun, and more worthy of conversation at cocktail parties. But if you
go with bonds, you might skip the party altogether and fund that island vacation that sounds vastly more enticing in any case. As always, do your
own homework, and pay close attention to valuation and discounts before pulling the trigger.
4 of 11 1/11/2014 1:27 PM
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2014: The Case For 'Reverse Rotation' Into Bond CEFs by Arsene Lupin
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omarbradley Comments (402)

I don't accept the greater fool theory. "be invested...that includes stocks." Having said that i do accept "The Greatest Fool Theory." there is
nothing unusual about "buy at any price" investing. we've had two massive manias in the last two decades...this one "clearly is not a third"
(how many 300% gainers on no earnings this year?)
24 Dec 2013, 03:30 PMReplyLike0
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5 of 11 1/11/2014 1:27 PM
Zach Mansell Comments (221)

Tesla fits the bill. Amazon may too depending on who you ask. Twitter as well. Of course that's just limited to tech.
Any long term indicator of value suggests that stocks are due for a 30-40% correction (Tobins Q, CAPE, mean reversion in profit margins,
etc. ). It's anyone's guess as to when, but I think it's likely in the next 2 years or so.
omarbradley Comments (402)

just look at Solar stocks. Crazy moves all year...but if you'd bought the sell off in the Fall you'd have missed a huge winter rally. same goes in
the opposite direction for mining stocks. they got crushed this summer...and everyone got suckered in and bought and are now finding their
mining plays are rolling over as the market sees them as "loss leaders." at some point in the next six months a little "vulture investing" might
be in order in the mining space. no need to rush it. at a certain level "everything is over-valued" which is why folks don't get in the market to
begin with.
Arsene Lupin Comments (171)

I'll buy that vulture investing in metals & mining will make sense (may already be there). As Shipping goes to show, when
these spaces turn, they turn quickly.
GrowthGeek Comments (268)

I guess I'm dense, but have always remained 100% in stocks with the money I personally control. I just don't understand the argument for
bonds. Ownership beats loanership over time. Yes, I expose myself to more volatility, but over time I'm destroying the return of bonds. Even
if I was more conservative and/or needed considerable income from my investments--why wouldn't I invest in NMM with a 10% return in a
cyclical area that is making a comeback? Or if I wanted lower volatility than the SPY with a decent dividend how about JNJ? Help me see
the error of my ways as I'm in my 50's now and all the big investment houses tell me I should be rotating out of stocks into more conservative
investments. What's wrong with me???
6 of 11 1/11/2014 1:27 PM
GD Comments (612)

I'm 80. Your on a good track.
Good paying bonds I bought years ago, are maturing , and new ones pay very little.
I'm taking the proceeds, and buying equitys w/ good growth, and good Divs with good CAG. Would have been better off if I started
earlier--"too soon old, too late smart---"
WallStreetDebunker Comments (1716)

Geek, we've had 20 years of mostly high CAPE valuations on stocks. If the US stock market swings to 20 years of unusually low CAPE
valuations--as has occurred a couple of times in history--your stocks might be very poor performers. This means you'll have less money to
spend when you need it most in your older years. This is exactly why asset allocators recommend an increase in the proportion of assets that
have low correlation to stocks for older people.
Americans can't fathom the possibility of perennially cheap stock valuations, especially after a 5-year bull market.

If you bought JNJ in the low 60's or NMM at 13, brilliant (NMM got away from me right around the secondary). But if it's a
choice between bonds yielding 7% tax free and JNJ in the 90's?

There has never been an era with even a fraction of the number of speculative manias that have occurred in the last 15 years. Is it a
monetary policy issue or a Baby Boomer issue or both?

Or perhaps the fact that most trading is done by machines, and these machines use algorithms that are fairly similar and come
to similar conclusions (rightly or wrongly) at the same time.
7 of 11 1/11/2014 1:27 PM
birder Comments (975)

Earlier this year after many of my muni bonds were called I took a 2nd look at muni CEFs. After all 7% tax free is nothing to sneeze at
especially when one can pick that up with AA rated paper at a 10% discount to net assets. I picked through the universe and found a couple
that at the time met this criteria. Today they do not sell at such a steep discount but one still does yield 7%. BYM is the 7% yielder. The other
EIV is currently at 6.8%. Considering that these two in the past year had sold at prices almost 30% higher than currently it seems that much
of the risk has been replaced with potential reward. The universe of muni CEFs is rather large and rather complex with more than 200
choices. The site that I use to sort through the offerings is CEF Connect. All of these CEFs are very thinly traded so it is very important to
place a limit order when placing orders and unless you are not opposed to picking up bits and pieces all or nothing also.
It does appear at least from the charts that the muni CEFs have hit a bottom recently and prices are turning to the upside.
25 Dec 2013, 09:45 AMReplyLike1
R we there yet Comments (319)

I have been a steady purchaser of muni CEFs specific to my state residence for the last 6 months or so.
Yeah, boring, dull and cant touch equities for return, I know.
But it is not my only portfolio and the tax free income is a huge plus for me. For some of the cefs the returns are close to 14% if you discount
for the tax advantage. I have trouble attaining that in equities unless I reach into some risky areas.
Lets just say I am a bit too "mature" for that.
As another writer mentioned, these are thinly traded so its best to go in a few hundred shares at a time or you can amass some large trade
fees buying anywhere from 1 to 21 shares at a time. Voice of experience.
Thanks for writing this Arsene.

R we there .. sounds like you've good timing. Here's to that continuing. And yes, CEF's are getting to the point where some
hedgies (who get none of the tax benefits) are playing them in any case as a premium play ..
Akaralph Comments (1327)
8 of 11 1/11/2014 1:27 PM

None of the taxable bond funds in your table are even close to the 52 week low discount to NAV.
Would avoid any of these until the discounts approach the 52 week lows.
25 Dec 2013, 10:00 AMReplyLike0

um .. really? how about DSL?
GrowthGeek Comments (268)

Well Arsene and Debunker--I've held stocks for 35 years and have seen some pretty steep declines, but I've still destroyed bond returns over
time. Patience is a virtue. If I was a betting man, and maybe you think I am given my portfolio--I'd certainly pick JNJ over your picks Arsene
over the next 5 years. The 80 year old and I are having trouble seeing the error of our ways.

@GrowthGeek I wouldn't say you're wrong at all. JNJ and NMM/CPLP are good choices. The question isn't outperformance
over a 5 year horizon (bonds have very long odds on that). The question is, outperformance in the 3 to 18 month time horizon. If you're
buying stocks to live on the divvy stream and ride out any gyrations, life is quite simple - 100% dividend growth stocks. Not everybody has
that luxury.
Venu

Geek, Until late 2011, the 10-year treasury outperformed the S&P 500 for the prior 30 year period, with minimal risk and a fraction of the
volatility.
If you need your money at a time that coincides with the bottom of a 40-55% bear market, your vision might clear up.
9 of 11 1/11/2014 1:27 PM
Zach Mansell Comments (221)

There are periods that are 10-20 years long where equities under perform bonds. In the long, long run equties usually do outperform bonds -
but not everyone has the ability to wait 10-20 years for that guarantee to happen. By most measures, U.S. equities are expensive. This
doesnt guarantee a crash. It just raises the likelihood that bonds will outperform over the middle term. If you can get CEFs that yield 7-10%
at 10% discounts, youre getting average equity returns with a margin of safety and more consistent cash flows. I dont think thats a bad deal
in this over-priced environment. Sure, CEFs are unlikely to return 25-30% a year like equities did this year. Theyre also unlikely to fall 50%
like equities did in 2000 and again in 2008.

@Zach well put
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