The third-quarter market correction came like a kick to the teeth. But if you blinked, you might have missed it.
From August 17 to August 25 – a span of a little less than a week – the S&P 500 dropped a quick 11%.
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But by the middle of October, the market had already recovered more than half of the late-summer swoon.
In certain sectors – like energy – the August selloff created the sort of pricing that makes value investors like me salivate.
Pricing is still very favorable in this sector, and I am seeking additional opportunities that meet my value criteria.
But in the broader market, the correction – while violent and jarring – was not deep enough to really give us the bargains I had hoped for. U.S. stocks are still very pricey, trading at a cyclically-adjusted price/earnings ratio of 25, implying extremely lackluster returns going forward.
So, mainstream stocks are a bad bet at today’s prices. But I believe there are bargains to be found for those willing to look.
One corner of the market that is dirt cheap right is closed-end bond funds (CEFs).
This is a niche market that is mostly ignored by institutional investors and even seems a little anachronistic in the age of index-tracking ETFs.
But their quirkiness is precisely what makes them appealing.
Unlike mutual funds – which are priced daily at NAV – or ETF shares – which rarely deviate too far from their NAV – CEFs are often priced at wild discounts and premiums to the values of their respective portfolios.
When a CEF is priced at premium to its book value, you generally don’t want to own it. Why would you pay $1.10 for a dollar’s worth of assets?
An enterprising investor could look at the fund’s holdings and replicate them by buying the same bonds on the open market… without paying management fees.
But when a CEF trades at a discount…that’s where it gets interesting. In several high-quality CEFs, we can essentially pick up dollars for 90 cents or less.
Stocks I’m currently keeping an eye on are the Cohen & Steers Select Preferred and Income Fund (PSF), the Cohen & Steers REIT and Preferred Fund (RNP), the Eaton Vance Limited Duration Income (EVV) and the Cohen & Steers Limited Duration Preferred & Income Fund (LDP).
All are trading at discounts to book value of 10%-17% — some of the deepest discounts since the 2008 meltdown – and all pay very competitive dividends of 8%-10%.
Between the dividends and a closing of the discounts to more “normal” levels, I hope to see total returns of 15%-20% over the next 12-18 months. In an overpriced market, that’s not too shabby.
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