Far too many investors think that inflation is bad news for closed-end funds (CEFs), for one simple reason: they fear that it will increase CEF borrowing costs. (Because CEFs, of course, use leverage to varying degrees.)
It sounds like a reason to be concerned. Inflation, after all, raises interest rates, and higher rates obviously mean that CEFs would have to pay more to repay their loans.
Bad news, right?
Not so fast! Because almost everyone forgets the other side of the story – that with inflation (at least these days) comes a strong economy – and that generates returns on investment that will more than make up for it. increase in CEF borrowing costs.
Today we’re going to take a look at what the current inflation situation means for our CEF Insider portfolio. Next, we’ll look at a CEF with a 5.1% dividend that is perfectly set to profit in this new high inflation, high growth world.
Forget the Hype: Let’s Put This Inflation ‘Push’ in Context
One thing that holds many investors back these days is the magnitude of the latest spike in inflation: a 5% jump in May, the biggest consumer price hike since 2009. But we have to look beyond it. of that single number to get the real story. , something the market (for once!) seems to understand. Equities are trending upward, despite rising fears about inflation and rates:
Stocks defy inflation fears, roll higher
This is our first clue that these inflationary fears are exaggerated. The other thing to keep in mind is that inflation isn’t as bad as it looks, if you look at May’s 5% figure in context.
Moderate inflation over time
Given that the number for May 2021 is compared to prices for May 2020, when the economic blow from the pandemic was reaching its full strength, it’s easy to see a big spike. In the longer term, however, inflation is subdued. Over three years, we have only seen 6.8% inflation, or 2.2% annualized, which is much closer to the 2% rate that the Federal Reserve set as its target.
This is half of our favorable configuration for CEFs. Now let’s look at the other side of our CEF ledger: the strong economy I mentioned earlier.
Wages rise to meet prices
We find that average hourly earnings, in nominal terms, are increasing at a higher rate in recent months as wages rise to match the higher cost of goods and services. Of course, this is no surprise; there has been an endless parade of stories of employers desperate for help, offered sign-up bonuses for certain jobs and an overall stronger position for workers.
It’s still unclear to what extent we can attribute recent price hikes to these higher wages, but early data suggests that higher wages are a big contributor. This raises business costs, of course, but it’s also a type of inflation that also drives up consumer spending – and by a lot!
Americans go shopping
This indicates a vibrant economy where people go to stores and buy things, and with vaccination rates still on the rise in the United States, you can expect more consumers to do so. Which, of course, is great for stocks.
About this CEF “Watch-List” …
In an era of wage growth and more aggressive consumer spending, most first-tier investors are opting for a consumer discretionary ETF like the Consumer Discretionary Select Sector SPDR Fund (XLY) or the Vanguard Consumer Discretionary ETF (VCR) . Yet both underperformed the S&P 500 in 2021.
Lag of popular ETF options
One problem with these funds is that they both have Tesla (TSLA) as the second largest stake, and Elon Musk’s company has been a major underperformance.
Tesla’s undernourished stock pulls ETFs down
While Tesla was obviously a great buy in 2020 (or, for that matter, since its IPO), the stock is hit now, shortly after it was added to those ETFs.
This kind of situation, of course, is why we prefer CEFs! Their managers can pull out of stocks like Tesla when they fall and are also free to build more balanced portfolios, not tied, as they are, to a major index.
And then there are the dividends. Consider a fund like the BlackRock Enhanced Capital and Income Fund (CII), which returns 5.1% outperforms ETF options. And it’s much better balanced, with Microsoft (MSFT), at 6% of total assets. It also gives you nice discretionary exposure to consumers through Amazon.com (AMZN), the industry’s biggest constituent, as well as one of the best ways to play on rising spending: Visa (V), which the network manages. a large portion of US retail transactions.
The best part is that CII’s management team sold Tesla before its last dive – a smart move that helped it avoid a drag on its net asset value (NAV, or the value of its underlying equity portfolio. ).
My top 4 CEF picks give an incredible 7.7% (and will skyrocket)
As strong as the CII is, it’s still not cheap enough to win us over, with its 3.3% discount to NAV. Instead, let’s pick up 4 more CEFs that are bringing in a good 7.7% today. This crushes the 5.1% ITC payment and gives you a viable income stream on a reasonable nest egg – with, say, $ 500,000 saved, you could earn a regular income of $ 38,500 per year in dividends!
Plus, these 4 funds are even better positioned than CII for big payouts due to their ridiculous discounts.
These surprising choices are game-changing in retirement, and all the details are just a click away. Get the full story of these 4 high yielding CEFs, including names, dividend histories, tickers and more, here.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.