Politics, schmolitics. The much-hyped events of last Thursday—former Federal Bureau of Investigation chief James Comey’s congressional testimony, the British election—turned out to be duds from the markets’ standpoint. The fireworks came on Friday, after a number of high-profile stock seers called time out, if not the end, on the mighty advance in the equity market, in particular the megacap technology stocks that have led the Nasdaq NDAQ 0.47001851588092863% Nasdaq Inc. U.S.: Nasdaq USD70.54 0.33 0.47001851588092863% /Date(1497042000441-0500)/ Volume (Delayed 15m) : 1091572 AFTER HOURS USD70.88 0.34 0.4819960306209243% Volume (Delayed 15m) : 29115 P/E Ratio 84.98795180722891 Market Cap 11597146791.6766 Dividend Yield 2.1548057839523675% Rev. per Employee 871676 More quote details and news » and most of the major averages to records.
The so-called FAANG stocks— Facebook FB -3.302953913774158% Facebook Inc. Cl A U.S.: Nasdaq USD149.6 -5.11 -3.302953913774158% /Date(1497042000161-0500)/ Volume (Delayed 15m) : 35541437 AFTER HOURS USD149.73 0.13 0.08689839572192513% Volume (Delayed 15m) : 36239 P/E Ratio 39.576719576719576 Market Cap 448308882321.231 Dividend Yield N/A Rev. per Employee 1776630 More quote details and news » (ticker: FB), Amazon.com AMZN -3.1635107446524198% Amazon.com Inc. U.S.: Nasdaq USD978.31 -31.96 -3.1635107446524198% /Date(1497042000509-0500)/ Volume (Delayed 15m) : 7512607 AFTER HOURS USD977.4 -0.91 -0.0930175506741217% Volume (Delayed 15m) : 135085 P/E Ratio 184.09009653199857 Market Cap 482883818751.648 Dividend Yield N/A Rev. per Employee 417613 More quote details and news » (AMZN), Netflix NFLX -4.732336628888353% Netflix Inc. U.S.: Nasdaq USD158.03 -7.85 -4.732336628888353% /Date(1497042000370-0500)/ Volume (Delayed 15m) : 10205636 AFTER HOURS USD158.8 0.77 0.48724925647029044% Volume (Delayed 15m) : 86318 P/E Ratio 207.93421052631578 Market Cap 71494945260.0293 Dividend Yield N/A Rev. per Employee 2023310 More quote details and news » (NFLX), and Google parent Alphabet GOOGL -3.4014418289719996% Alphabet Inc. Cl A U.S.: Nasdaq USD970.12 -34.16 -3.4014418289719996% /Date(1497042000209-0500)/ Volume (Delayed 15m) : 3555532 AFTER HOURS USD971.5 1.38 0.14225044324413474% Volume (Delayed 15m) : 92325 P/E Ratio 32.784292521374745 Market Cap 687468184012.039 Dividend Yield N/A Rev. per Employee 1309660 More quote details and news » (GOOGL)—with the second A added with the inclusion of Apple AAPL -3.8776695270662622% Apple Inc. U.S.: Nasdaq USD148.98 -6.01 -3.8776695270662622% /Date(1497042000189-0500)/ Volume (Delayed 15m) : 63583341 AFTER HOURS USD148.96 -0.02 -0.013424620754463686% Volume (Delayed 15m) : 1299326 P/E Ratio 17.424561403508772 Market Cap 808093066023.29 Dividend Yield 1.6915022150624246% Rev. per Employee 1894280 More quote details and news » (AAPL)—had accounted for over two-fifths of the Standard & Poor’s 500 index’s gain in market value this year, The Wall Street Journal noted in a page-one piece on Friday. While pointing out that the rush into these big tech names was the most crowded trade anywhere, one money manager opined that it wasn’t about to end anytime soon.
Famous last words. Robert Boroujerdi, head of global securities research at Goldman Sachs, issued a report on Friday warning that the big tech stocks—including Microsoft MSFT -2.26546212647672% Microsoft Corp. U.S.: Nasdaq USD70.32 -1.63 -2.26546212647672% /Date(1497042000509-0500)/ Volume (Delayed 15m) : 48318146 AFTER HOURS USD70.38 0.06 0.08532423208191127% Volume (Delayed 15m) : 869250 P/E Ratio 31.115044247787612 Market Cap 555491040525.772 Dividend Yield 2.218430034129693% Rev. per Employee 761693 More quote details and news » (MSFT), which he added to make it FAAMG—had become way too crowded a trade. (The market caps of Netflix and Nvidia NVDA -6.464924346629986% NVIDIA Corp. U.S.: Nasdaq USD149.6 -10.34 -6.464924346629986% /Date(1497042000463-0500)/ Volume (Delayed 15m) : 91968597 AFTER HOURS USD149.44 -0.16 -0.10695187165775401% Volume (Delayed 15m) : 354599 P/E Ratio 49.70099667774086 Market Cap 95164301452.6367 Dividend Yield 0.37433155080213903% Rev. per Employee 732304 More quote details and news » [NVDA] are too small to influence the cap-weighted S&P 500, he wrote.) The surge in FAAMG made for exalted valuations that recalled the Nifty 50 of the early 1970s or the dot-com era of 1999-2000, lifting them to lofty perches whence they could take a nasty spill.
But the FAAMGs’ steady ascent also had the counterintuitive effect of lowering the megacap tech stocks’ perceived risk to less than that of traditionally defensive sectors, such as consumer staples and utilities, Boroujerdi wrote in his much-discussed note. That’s because the big-cap techs’ steady ascent had lowered their volatility.
And just as truth is beauty and vice versa to poets, volatility and risk are the equivalent to those steeped in modern finance. A steady climb in a stock’s price makes it appear less risky. But megatechs’ low realized volatility can lead investors to underestimate the risks inherent in their businesses, such as cyclicality, regulation, or disruption. Then the volatility of FAAMGs could surge, leading to a reversal of the influx of money into the sector, Boroujerdi explained.
Investors weren’t waiting for that to happen. Apple, the world’s biggest-cap stock, shed a massive 3.9% of its value on Friday, contributing mightily to a 1.8% plunge in the Nasdaq Composite. Facebook surrendered 3.3%; Alphabet, 3.4%; Amazon, 3.2%; and Microsoft, 2.3%. That added up to a combined paper loss of over $97 billion that day in these supposedly low-risk stocks. To put that in perspective, Boroujerdi said their appreciation this year had totaled $600 billion before Friday’s haircut, equal to the gross domestic products of Hong Kong and South Africa combined.
Friday also brought a number of warnings from other Wall Street worthies. David Bianco, chief investment strategist for the Americas at Deutsche Asset Management, advised clients that the rally “has reached its near-term limits and is vulnerable to summer fatigue and rising anxiety over whether Congress can make pragmatic decisions.” That makes the next 5% move in the S&P 500 likely to be lower, he concluded.
Guggenheim Global Chief Investment Officer Scott Minerd wrote that “stock and bond markets have rarely been more expensive and stable, and that has me worried.” The apparent complacency “argues for caution” and “dry powder” to take advantage of opportunities as volatility picks up later in the year.
Yet amid the tech wreck, the S&P 500 shed just 0.08% on Friday and 0.3% for the week, while the Dow Jones Industrial Average ended at another record, up 0.42% on Friday and 0.31% for the week. That implies that money exiting the megatechs ended elsewhere, a lot of it apparently into energy stocks, with the Energy Select Sector SPDR XLE 2.4051803885291396% Energy Select Sector SPDR ETF U.S.: NYSE Arca 66.42 1.56 2.4051803885291396% /Date(1497056400000-0500)/ Volume (Delayed 15m) : 22194645 AFTER HOURS 66.51 0.09 0.13550135501355012% Volume (Delayed 15m) : 989555 P/E Ratio N/A Market Cap N/A Dividend Yield 2.5234266787112314% Rev. per Employee N/A More quote details and news » exchange-traded fund (XLE) popping 2.41%—a sector, colleague Andrew Bary notes on page 15, that had become undervalued.
The rotation also found its way into banks and other financials, with the Financial Select Sector SPDR XLF 1.8875838926174497% Financial Select Sector SPDR ETF U.S.: NYSE Arca 24.29 0.45 1.8875838926174497% /Date(1497056400003-0500)/ Volume (Delayed 15m) : 129018784 AFTER HOURS 24.36 0.07 0.2881844380403458% Volume (Delayed 15m) : 4197416 P/E Ratio N/A Market Cap N/A Dividend Yield 1.447558666117744% Rev. per Employee N/A More quote details and news » ETF (XLF) jumping 1.9% on Friday. Financials appear to be benefiting from a rollback of the Dodd-Frank regulatory legislation that passed the House of Representative on Thursday. An uptick in 10-year Treasury yields from their lowest level just after November’s election also gave a boost to banks and prospects for increased net-interest margins.
The Federal Reserve’s Open Market Committee meets this week and is all but certain to announce a quarter-point increase in its federal-funds target range on Wednesday. Fed watchers and investors will be looking for clues about the course of policy for the rest of the year, especially any shrinkage in the central bank’s $4.5 trillion balance sheet. That ought to be a major topic in Fed Chair Janet Yellen’s post-confab press conference.
With increasingly contentious politics in Washington, the Trump pro-growth policies get pushed further into the future, which leaves monetary policy to provide the main fuel for the bulls. Central banks around the globe have pumped in more than $1.5 trillion of liquidity already this year, Bank of America BAC 3.04745319982586% Bank of America Corp. U.S.: NYSE USD23.67 0.7 3.04745319982586% /Date(1497042029637-0500)/ Volume (Delayed 15m) : 107371805 AFTER HOURS USD23.74 0.07 0.2957329953527672% Volume (Delayed 15m) : 882514 P/E Ratio 14.981012658227849 Market Cap 228595122707.589 Dividend Yield 1.267427122940431% Rev. per Employee 455101 More quote details and news » Merrill Lynch investment strategists point out in a research note.
But Guggenheim’s Minerd recalled Baron Rothschild’s secret of his fortune—that he always sold too early. It might be wise to follow the baron’s example and “take some chips off the table,” he concluded.
Bank depositors looking for a raise after the Fed boosts its interest-rate target shouldn’t hold their breath. A better place to wait for Yellen & Co.’s largess to trickle down might be in funds that invest in floating-rate bank loans.
A couple of weeks ago, our colleague Amey Stone warned in her Current Yield column of the increasing risks in some bank-loan mutual funds and ETFs, notably because terms for borrowers have gotten looser, leaving less protection for investors. In addition, some closed-end loan funds have sold off in recent weeks, perhaps reflecting fading expectations for further Fed hikes this year after this coming week’s widely anticipated move, following double-digit returns in the past 12 months in many cases.
As a result, discounts on loan closed-end funds have widened—at the same time that stocks have rallied to records and bond yields have slumped to lows. (Closed-end funds can trade above or below their net asset values, unlike open-end funds, which are sold or redeemed at NAV, and ETFs, which rarely diverge from their NAVs.) The rich valuations extend to the junk-bond sector, with the popular iShares iBoxx $ High Yield Corporate Bond HYG 0.07932011331444759% iShares iBoxx $ High Yield Corporate Bond ETF U.S.: NYSE Arca 88.32 0.07 0.07932011331444759% /Date(1497056400001-0500)/ Volume (Delayed 15m) : 9912921 AFTER HOURS 88.32 % Volume (Delayed 15m) : 501940 P/E Ratio N/A Market Cap N/A Dividend Yield 5.124673913043479% Rev. per Employee N/A More quote details and news » ETF (HYG) trading near a 52-week high and belying its name with a relatively paltry 5.1% yield—less than my grandmother’s passbook savings account did, back in the day.
In contrast, some loan CEFs provide higher yields—above 7% in some cases—with a margin of safety in the form of discounts as wide as 8%. To be sure, there is more risk than with a savings account. Loan funds have exposure to below-investment-grade credits, just as junk funds do.
But loan funds rank higher in the capital structure and have interest rates that typically float above the London interbank offered rate, which is higher than the federal-funds rate; three-month Libor on Friday was set at 1.221%, compared with the Fed’s current funds rate target of 0.75% to 1%. As with most CEFs, the loan variety uses leverage to boost yields, which also adds risk. But the floating-rate nature of its assets offsets the risk of rising borrowing costs.
Closed-end loan funds that have seen marked widening of discounts recently include Invesco Dynamic Credit Opportunities VTA 0.16570008285004142% Invesco Credit Opportunities Fund U.S.: NYSE 12.09 0.02 0.16570008285004142% /Date(1497042123464-0500)/ Volume (Delayed 15m) : 376410 P/E Ratio N/A Market Cap N/A Dividend Yield 7.0471464019851116% Rev. per Employee N/A More quote details and news » (VTA), which closed on Thursday at an 8.14% discount and a yield (based on its share price) of 7.06%. The Nuveen Credit Strategies Income JQC 0.11587485515643106% Nuveen Credit Strategies Income Fund U.S.: NYSE 8.64 0.01 0.11587485515643106% /Date(1497042121401-0500)/ Volume (Delayed 15m) : 466999 P/E Ratio N/A Market Cap N/A Dividend Yield 7.291666666666667% Rev. per Employee N/A More quote details and news » fund (JQC) sports a slightly higher yield, 7.3%, but a slightly smaller discount, 7.6%. These closed-ends have a portion in junk bonds as well as loans, with correspondingly higher yields and somewhat greater risk.
CEFs with the lion’s share of assets in floating-rate loans that have seen a widening in their discounts recently include Apollo Senior Floating Rate AFT -0.40863981319322823% Apollo Senior Floating Rate Fund Inc. U.S.: NYSE USD17.06 -0.07 -0.40863981319322823% /Date(1497042121142-0500)/ Volume (Delayed 15m) : 82074 P/E Ratio 7.138075313807532 Market Cap 266765490 Dividend Yield 6.330597889800703% Rev. per Employee N/A More quote details and news » (AFT), with a 6.3% yield and a 5.83% discount, and Pioneer Floating Rate Trust PHD 0.25359256128486896% Pioneer Floating Rate Trust U.S.: NYSE 11.86 0.03 0.25359256128486896% /Date(1497042121432-0500)/ Volume (Delayed 15m) : 55658 P/E Ratio N/A Market Cap N/A Dividend Yield 6.070826306913997% Rev. per Employee N/A More quote details and news » (PHD), with a 6.09% yield and a 5.81% discount.
These loan funds appear to offer more attractive yields and valuations than another type of CEF: term trusts, which have seen renewed popularity in the past year. The trusts have termination dates, typically three to seven years from their initial public offerings, which are supposed to limit their interest-rate risks.
In intramural matchups, the Invesco High Income 2023 Target Term IHIT 0.09940357852882704% Invesco High Income 2023 Target Term Fund U.S.: NYSE 10.07 0.01 0.09940357852882704% /Date(1497041749398-0500)/ Volume (Delayed 15m) : 25600 P/E Ratio N/A Market Cap N/A Dividend Yield 5.958291956305859% Rev. per Employee N/A More quote details and news » fund (IHIT) yields 5.96%, while the Nuveen High Income November 2021 Target Term fund (JHB) yields 5.92%. Both are more than a percentage point lower in yield than their respective corporate-loan cousins, while the term trusts trade at less than a 1% discount to NAV.
To be sure, the loan funds don’t have a termination date, unlike the term trusts, which aim to return their original NAV on that date. But according to a research note from the Wells Fargo Advisors closed-end research team headed by Mariana Bush, as term trusts approach their termination date, it’s possible they will reduce their distributions, which investors should be prepared for.
As the Fed normalizes short-term interest rates, loan funds should see their distributions rise. To be sure, if junk bonds get hit—as they did last year when oil prices tumbled—loan CEFs could follow them lower. In contrast to stocks and high-yield bonds trading at exalted valuations, however, the recent dip in some loan CEFs offers a margin of safety.
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