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5 Outperforming CEFs That Are Insulated From Market Corrections

Summary The 2015 market correction caused a 10% drop across the market, but some CEFs were unaffected. Investing in market-neutral CEFs can help you protect your portfolio in the event of an event. I present a list of the 5 most profitable CEFs that are also uncorrelated to the general market. The previous market correction was a three-day selloff that led us to a market that trended sideways for two months. In total, the market lost 10% of its value before climbing back to its original place: (click to enlarge) Knowing not to freak out and to hold onto your investments is good, but having investments that are uncorrelated to the general market in the first place is better. This article is a follow-up to two other articles on investments uncorrelated to the S&P 500. The first article was on investment categories; the second on index funds. This article will be on CEFs, as per a reader request: (click to enlarge) Correlation In my previous article, I used a five-year lookback period. But if we are to really consider these investments uncorrelated to the market, they should not fall when the market does. Hence, the following comment: For this purpose, in this article, I will only be looking at the most recent market correction as my lookback duration. Thus, the correlation calculation will be from August to November, 2015. Whenever we look at the correlation of two investment instruments, we must use the log of those investments. In this way, we find the correlation of returns, not simply price movement. The result will tell us whether two investments are likely to give the same returns over our lookback period. I wrote some R code to screen CEFs according to the following criteria: Trading above $5 (therefore not a penny stock). Has a correlation of less than 0.3 (in magnitude) to the SPDR S&P500 Select ETF (NYSEARCA: SPY ). I then arranged those CEFs in order of greatest return over the past year. I chose the top five CEFs in this list to present to you. Because the top five actually had 3 municipal bond CEFs, I went down the list to add 2 more CEFs outside of this category. The Winners Nuveen Long/Short Commodity TR (NYSEMKT: CTF ) This CEF is a portfolio of long and short futures contracts. CTF purposefully plays a flat game, not taking too many long or short positions. Though it would have been nice to see CTF short energy, making their shareholders lots of cash over the past couple years, CTF has avoided such high-volatility trades. Though CTF’s Nav growth is rather slow, dipping into negative territory, this CEF is trading at a decent discount: -4.36%. The yield is currently 7.54%. Whether CTF can maintain these payouts at its current Nav growth is questionable. The discount is disappearing, however. The discount bottomed out at over -20% in 2014 and has recently bounced back. Thus, if you’re interested in getting in on this high-yield CEF, you should consider doing it soon. Remarkably, CTF is the only CEF in the top five that is not a bond-based fund. Correlation with market-correction phase SPY: 0.27 Babson Capital Corporate Invs (NYSE: MCI ) Here, the focus is on non-investment grade corporate debt. The equities involved are conversion rights, preferred shares, and warrants. Because of the inclusion of conversion rights, the debt here is convertible, which can lead to a dilution of shares. Nevertheless, the yield is high, at 6.80%. However, the surge in price has caused MCI to outgrow its Nav. The Nav sits at a stable 14.70, while the CEF trades at over $17. This CEF is selling at a 10.82% premium. If you buy this CEF, you will be overpaying for the portfolio. But for a long-term investment, MCI seems to provide noteworthy returns. Correlation with market-correction phase SPY: 0.19 Municipal Bond CEFs EV NJ Municipal Bond (NYSEMKT: EMJ ) Blackrock VA Municipal Bond (NYSEMKT: BHV ) Blackrock Muniyield Arizona (NYSEMKT: MZA ) These CEFs offer generous distribution rates of around 5.00. Both BHV and MZA trade at a premium, while EMJ trades at a slight discount. That discount is soon to be gone, as it has been shrinking over the past year. Buying a municipal bond fund can especially benefit you via tax exemptions if you live in a state with high taxes, as these bonds are tax-free investments in most cases. However, realize that EMJ will cause you to pay capital gains taxes on your investment, as it is currently trading at a discount. All of these regions – New Jersey, Virginia, and Arizona – are, to my knowledge, in good shape. But you should perform due diligence and ensure that the local governments aren’t facing problems of paying their debts. Residents in states with high taxes, such as New York, New Jersey, and California, should consider these CEFs. EMJ’s correlation with market-correction phase SPY: -0.09 BHV’s correlation with market-correction phase SPY: 0.25 MZA’s correlation with market-correction phase SPY: -0.11 Doubleline Opportunistic Credit (NYSE: DBL ) With a yield of 8.22, it’s no surprise that DBL isn’t trading at a discount. DBL has almost consistently been trading at a premium. But there have been dips into the discount region. An investor looking for a good deal might keep an eye on DBL and buy at one of these rare discounts. Just remember that a drop in the premium/discount will also typically drop the yield toward the sector’s average. In addition, as time goes on and rates increase, credit-based CEFs such as DBL will likely take a hit. You should also consider leverage here, as rates will likely be rising in the future. Higher leverage implies higher borrowing fees for the fund. DBL might be a good short-term hold, but you should consider dropping it for non-credit CEFs with less leverage before rates rise. Correlation with market-correction phase SPY: 0.02 Strategic Global Income (NYSE: SGL ) Speaking of leverage, here’s a non-leveraged CEF. Previously trading at one hell of a discount, SGL is now trading at “only” a -4.12% discount. This offers the highest discount of all the market-neutral CEFs we looked at today, with a yield of 9.42%. As the name suggests, SGL invests in global bonds. Its holdings branch from Argentina to Russia. These bonds are diversified, with both sovereign paper and corporate notes in the mix. Although a portfolio of such a wide geographical array of holdings is more likely than a focused portfolio to encounter a holding that cannot repay its debt, the fact that SGL is diversified should minimize such problems. The risk is there, but the reward is higher, I believe. This fund doesn’t have many downsides other than the exposure to iffy countries (the average credit rating of SGL’s holdings is still A) and the fact that SGL is taxable. Correlation with market-correction phase SPY: 0.11 Conclusion Overall, we have a wide selection of market-neutral CEFs that can help us generate stable income even during a market correction or crash. Of the five we looked at, I would recommend SGL most to investors in low-tax states, while recommending the municipal bond CEFs to investors in high-tax states. But no matter your choice, rest assured that these CEFs will be least affected by another market correction. Obviously, I simply don’t have the time to cover every industry. While reading this article, you probably thought of at least one investment that should have gone in my “Winners” section. Let me know about it in the comments section below. Request a Statistical Study If you would like for me to run a statistical study on a specific aspect of a specific stock, commodity, or market, just request so in the comments section below. Alternatively, send me a message or email.

Finding Value With The Piotroski F-Score: Results

The final results of the Piotroski F-Score experiment. The portfolio lost half of its value mainly due to the fall in the price of oil. The experiment wasn’t a total failure. It has been a year since I began my Piotroski F-Score experiment (Finding Value With The Piotroski F-Score). Unfortunately, the results of the experiment are less than impressive, although the unexpected collapse in the price of oil is partially to blame. You can find the first part of this series, which explains the methodology behind the F-score, as well as an initial summary for each company, here . The second part, assessing the portfolios performance up to the beginning of February can be found here. Part three. Part four. The thesis behind my F-Score experiment was simple. The Piotroski F-Score was designed to hunt out value opportunities that are profit-making, have improving margins, don’t employ any accounting tricks and have improving balance sheets . As a contrarian value investor, I was interested in seeing how this strategy performed in the real world. It is both a way to discover value stocks and trade them without fundamental analysis, the screening criteria and investments are based purely on the financials (something Benjamin Graham recommended). Piotroski recommended scoring the bottom 20% of the market in terms of price to book value and rating these companies based on how many F-Score criteria they passed. The criteria looked at points such as leverage, liquidity, profitability and operating efficiency. One point is awarded for each criterion the company passes and the stocks that score the highest, eight, or nine are regarded as being the strongest candidates for recovery. Using the following system, Piotroski’s April 2000 paper Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers, demonstrated that the Piotroski score method would have seen a 23% annual return between 1976 and 1996 if the expected winners were bought and expected losers shorted. This time last year I selected 20 companies that passed Piotroski’s criteria and were, at the time of initial investment, trading below book value per share. I constructed a hypothetical portfolio investing $1,000 in each company excluding commissions. The positions were based on financial data only with no weighting to fundamental factors. The companies selected were: Noble (NYSE: NE ), Ternium SA (NYSE: TX ), Unit (NYSE: UNT ) Ocean Rig (NASDAQ: ORIG ), CYS Investments (NYSE: CYS ), Pacific Drilling (NYSE: PACD ), Hornbeck Offshore Services Inc (NYSE: HOS ), OM Inc. (NYSE: OMG ), Speedy Motorsports (NYSE: TRK ), Gulfmark Offshore Inc (NYSE: GLF ), Schnitzer Steel Industries Inc (NASDAQ: SCHN ), Bill Barrett (NYSE: BBG ), Penn Virginia (NYSE: PVA ), Steel Excel Inc (OTCQB: SXCLD) McClatchy Co (NYSE: MNI ), Ducommun Inc (NYSE: DCO ), Vantage Drilling Co (NYSEMKT: VTG ), Nuverra Environmental (NYSE: NES ), Willis Lease Finance (NASDAQ: WLFC ) and Ellington Residential Mortgage (NYSE: EARN ). How did the portfolio perform? (click to enlarge) Values taken after market close 11/20/2015. A 49.32% loss in 12 months is a terrible performance. Dividends received over the period totaled $61.20, although these cash payments didn’t do much to soften the blow. OM Group was taken p rivate by Apollo Global . It’s clear that turbulent oil markets were to blame for this underperformance. There’s no way the strategy could have identified or prevented the carnage in the oil sector over the past year or so. And there is no reason to give up on the F-Score after just one year of poor returns, so I’m going to continue the experiment for another year but make several adjustments. A new crop of stocks will be selected using the same criteria as the ones that qualified last year. However, this time around I’m also going to short hypothetically the 20 worst stocks — as the original F-Score study suggested. Moreover, I’m going to run another portfolio alongside the one described above which will exclude all resource stocks. I’ll be publishing the details of these two portfolios over the next week. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Why Stocks Are Getting Riskier By The Day

Borrowing costs are set to move higher. Higher borrowing costs could force American companies to curtail the debt that they’ve raised to buy back shares of their own stock. Not only would stock prices struggle to move higher if corporations are not buyers of as many shares as they have been in the past, but a lessening in stock buybacks would reduce the perception of corporate profitability. These headwinds to stock valuations as well as future returns – near-term and longer-term – are not easily dismissed. The central bank of the United States (a.k.a. the Federal Reserve) may hike its overnight lending rate in December. Committee members are also discussing plans to phase out the reinvestment of principal on balance sheet securities. Translation? Borrowing costs are set to move higher. The Fed is tightening for the first time in nearly a decade. In so doing, it is implicitly signaling faith in the U.S. economy’s ability to accelerate. The question investors might want to ask is whether or not that conviction is misplaced. For one thing, if the U.S. economy continues to expand at the same sub-par recovery rate of 2.2% per year, stock valuations will move from overvalued to insanely valued. Consider the ratio of total U.S. stock market capitalization to the broadest quantitative measure of U.S. economic activity, gross domestic product (GDP). With total market cap at nearly $21.6 trillion and GDP at at roughly $17.9 trillion, the ratio sits at 120.8%. The historical average since 1970? About 72.5%. Investors should recollect that Warren Buffett described Market-Cap-To-GDP as the “best single measure of where valuations stand at any given moment.” It follows that stocks are more expensive than they were before the financial collapse in 2008, though they are less expensive than they were prior to the tech wreck in 2000. If the ratio reverts to the historical mean of 72.5%? Then hold-n-hope advocates should prepare themselves for stock prices lose HALF of their current value. There are other concerns for investors should the economy prove less resilient than the Federal Reserve would like us to believe. Higher borrowing costs could force American companies to curtail the debt that they’ve raised to buy back shares of their own stock. Why is this so problematic? Not only would stock prices struggle to move higher if corporations are not buyers of as many shares as they have been in the past, but a lessening in stock buybacks would reduce the perception of corporate profitability. Remember, when a public corporation earning $0.70 per share (EPS) has one million shares outstanding, lowering the share count by 10% to 900,000 artificially pushes profitability per share up to $0.778. Were any additional products or services sold? Nope. The accounting wizardly plays itself out in more “reasonable” price-to-earnings (P/E) ratios that investors often use to determine valuation levels. Keep in mind, the buyback game has been happening for more than six-and-a-half years. Since 2009, debt-fueled share buybacks pushed earnings per share up 190%. Revenue from sales of products and services? Sales have increased an exceptionally modest 23%. With buybacks primarily funded by debt, higher borrowing costs sank the debt-funded buyback connection that was part and parcel of the previous market collapse (10/2007-3/2009). Is it unreasonable to suspect that this connection will follow a similar pattern? (click to enlarge) So if the Fed is wrong about the growth of GDP, and if it is wrong about the effect that higher borrowing costs will have on corporate credit expansion, stock valuations will surge. That’s true for Market-Cap-To-GDP. And that’s true for price-to-earnings (P/E). Yet there may also be an issue with the perception of a directional shift from a stimulative environment to a less stimulative one. Take a look at the relationship between the S&P 500 and the Fed’s balance sheet throughout the current bull market run. Each time that the Fed created electronic dollar credits to buy assets, expanded its balance sheet, and subsequently lowered borrowing costs, stocks rallied dramatically. In each of the three instances since the 2009 stock lows where the balance sheet remained the same? Stocks struggled to make meaningful strides. (click to enlarge) The possibility of the Fed reducing its balancing sheet. The danger of share buybacks rolling over. The unlikelihood of the U.S. economy breaking out in dramatic fashion. These headwinds to stock valuations as well as future returns – near-term and longer-term – are not easily dismissed. And that’s not even addressing the possibility that the domestic economy and/or the global economy weaken further. Is the consumer truly in great shape? Retail stocks in the SPDR S&P Retail ETF (NYSEARCA: XRT ) suggest otherwise. The exchange-traded fund hit new 52-week lows below the levels that we witnessed in the August-September sell-off. What’s more, we already know the recessionary struggles associated with manufacturers. Industrial production, which measures the amount of output from the manufacturing, mining, electric and gas industries, has fallen in nine of of the previous 10 months. There are few, if any, ways to put a positive spin on the declines in industrial production. (click to enlarge) And then we have the Fed telling us that “global market risks have diminished.” Really? How much further does copper – the metal with a Ph.D. in economics – need to fall before global market risks reignite? The iPath DJ-UBS Copper Total Return Sub-Index ETN (NYSEARCA: JJC ) has not only broken below August and September lows, it might as well have fallen off a cliff. Similarly, how much further does oil need to drop before oil producing exporters begin falling apart. The iShares MSCI Canada ETF (NYSEARCA: EWC ) is still toiling near its 52-week depths. No Virginia, global market risks have not diminished. For that matter, global economic deceleration is still the prevailing prognostication by the International Monetary Fund (NYSE: IMF ). China’s economic output is decelerating. Japan is already in recession. And European quantitative easing is not stimulating borrowing activity the way that it did in the U.S. In the end, all we have is the collective hope of voting members in the Federal Open Market Committee (FOMC). Hope that economic improvement will overcome lofty valuations and a pullback in corporate borrowing. Don’t get me wrong. Based on everything from “tax-loss harvesting” to “window dressing” to momentum investing, the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) may still represent the best diversified stock holding around. How long one should stick with those brass tacks, however, is another matter entirely. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.