The Perfect Way To 'Go On Offense' In 2023
Contrarian Outlook | Nov 03, 2022 05:34AM ET
Today’s market is ideal for us to grab stock-focused closed-end funds (CEFs) paying outsized 10%+ dividends. Here are three (of many!) reasons why:
- CEFs’ dividend yields are through the roof: As I just mentioned, many equity CEFs pay double-digit yields today.
- Deep discounts are everywhere: Of the 447 or so CEFs out there, the average fund trades at a 9.6% discount to net asset value (NAV). That’s near levels we saw in the darkest days of the pandemic! It’s totally overdone, which is why …
- Equity-CEF discounts have upward momentum. As you can see in the chart below, the average equity CEF’s discount has bounced from the depths it hit in October. Times like those—when CEF discounts are wide but starting to grind higher—are typically terrific buying opportunities.
Source: CEF Insider
I expect this momentum to continue, as it shows that CEF buyers are finally realizing the 2022 selloff is overdone. And there are plenty of reasons to believe it’s overdone. Consider, for example, the third-quarter GDP numbers for the US—they were solid, up 2.6% year over year.
To be sure, the main thing weighing on stocks (and CEFs) these days is the Federal Reserve. And if futures markets are right, there are still four months to go before the Fed is likely to pause to let its 2022 rate hikes sink in.
But there’s a disconnect we CEF investors can profit from here, too: although the Fed has hiked rates faster than it has in generations, Americans are still flush with cash.
Of course, inflation remains a challenge, but Americans’ disposable income has hit all-time highs (if we ignore spikes caused by pandemic stimulus payments).
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And get this: household balance sheets are so strong that even with higher rates, Americans are spending less than ever on interest (again, with the exception of the pandemic years).
The federal government’s student-loan forgiveness program will likely cut this number further, strengthening consumer spending even more.
h2 An Ignored (for Now) 11%-Yielding Equity CEF With Upside/h2The upshot here is that the potential for gains is strong, as lower debt-servicing costs and higher incomes support consumer spending—and corporate profits.
And the huge discounts in CEFs let us boost our gains even more. Plus, CEFs’ big yields translate the profits their portfolios generate into huge income streams we can collect as the market continues to recover.
One CEF I recommend paying close attention to now is the Virtus AI & Technology Opportunities Fund (AIO), which yields 11% and holds many blue-chip darlings, like UnitedHealth Group (NYSE:UNH), Deere (NYSE:DE) and Microsoft (NASDAQ:MSFT). AIO sports a 15.3% discount to NAV, so it’s much cheaper than it was in early 2022, when it traded around par.
h2 Double-Digit Gains Ahead as AIO’s Ridiculous Discount Bounces BackA discount as wide-ranging as AIO’s lets us get a sense of the gains we could see here. If AIO’s discount were to disappear, for example (like it did in late 2020 and late 2021—and I expect it to in the coming year), we’d be looking at a 17% price gain, and that’s before any appreciation from the fund’s portfolio.
Finally, don’t let the “AI” in the name throw you: AIO takes a broad approach to artificial intelligence, investing in firms that develop AI and other advanced technologies and use them in their businesses. That’s a smart, balanced strategy—and it explains why AIO owns stocks like UnitedHealth and Deere.
Disclosure: Brett Owens and Michael Foster are contrarian income investors who look for undervalued stocks/funds across the U.S. markets. Click here to learn how to profit from their strategies in the latest report, "7 Great Dividend Growth Stocks for a Secure Retirement ."
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