2016 Bounce Back Stocks: Bond, loan-based ETFs could surprise

Though increasingly perilous, the hunt for yield continues, and potential capital gains are the kicker here, leading us to consider some odd bounce back candidates.

This old railroad bond matured a long time ago. (Note the clippable coupons at the bottom.) Today you can buy a basket of muni bonds in a CEF or ETF. (Image via Wikipedia entry on bonds)

WASHINGTON, December 30, 2015 – Wednesday’s trading action find the bears back in charge of the market on a low-volume holiday week. Oil, which experienced a big price kick Tuesday, has given nearly all of it back Wednesday as oil inventories are back up once again, throwing the rest of the markets into a tizzy.

As of this writing (12 noon EST), the Dow is off about 46 points, the S&P is down 7 and the NASDAQ is off a little over 21. All three averages are being influenced in part by a hit to Apple (symbol: AAPL) due to reports of a tax settlement with Italy in the neighborhood of $348 million. Other American tech companies are caught in the cross hairs of other European governments in addition to Italy.

Like politicians anywhere in the world, if they see someone making too much money, they want as much of it as they can get, not to pay off outrageous national debts but to give even more money away to buy voters for another election cycle.

The money here for mega-giant Apple is a drop in the metaphorical bucket. But, combined with today’s oil blip, the HFTs have obviously shifted into high gear. With potential buyers out partying or yachting rather than trading, it will be interesting to see if hedge funds and other trading entities who need a higher market on December 31 to clinch those year-end bonuses can muster the guts to put all three averages in the green before COB New Year’s Eve.

Bounce back stocks for yield

Continuing our survey of potential year-end bounce back stocks—beaten down stocks and sectors that may experience a significant bounce after the end of the current tax year (midnight, December 31, 2015 to 0-dark 01, January 1, 2016)—we look at a few stocks that generally aren’t considered in this category; namely REITs, bond and bond-like Closed End Funds (CEFs), and financials, broadly defined.

Actually, all these stocks are “financials” in a way, given that they are interest rate sensitive and tend, in most cases, to offer decent and mostly stable yields, i.e., dividends. But as waves of interest rate fears battered the markets throughout 2015, many of these stocks were taken out back and shot.

Like Dracula, however, a number of them seem to be crawling back onto the trading radar given that they’ve been able to maintain yields in the face of all this. With tax-loss selling nearly at an end, they may end up offering a surprising opportunity for at least half-decent capital gains while still maintaining their high yields. This would be a blessing in 2016, which, according to most analysts, may very well be as dicey as the miserable year now ending.

BlackRock Defined Opportunity Credit Trust (BHL), PowerShares Senior Loan Portfolio (BKLN) and Pimco Municipal Income Fund (PMF). This trio of decent-yielding conservative vehicles was badly battered due to interest rate hike fears throughout 2015, but has recently begun to recover. In other words, the shares themselves aren’t quite the buy they were even a week ago. There’s a story here that unites all three, but we’ll get back to it in a moment.

Of these three stock-like vehicles, BHL and PMF are classed as CEFs, while BKLN is an ETF. Quick explanation. Back in the day, you could only buy portfolios of stocks via what were (and still are) known as mutual funds. Mutual funds are portfolios of stocks bought and sold by (presumably) expert managers who, over time, promised to deliver the kind of safety and decent returns that individual investors could only get from a diversified portfolio of major stocks.

Given that most individual investors aren’t wealthy enough to amass their own suitably diversified portfolios, mutual funds could provide them with a “slice” of this kind of portfolio if they bought shares in a given mutual fund. Mutual funds were (and still are) generally defined as “open-end funds,” in that if investors want more shares of a given fund than are currently available, the funds will take the money and buy even more shares of portfolio stocks to keep up with demand.

Over the years, however, investors complained about the sales commissions (“loads”) attached to most mutual funds, resulting in the creation of “no-load” mutual funds, which retained management fees but eliminated the sales charges.

More recently, funds have re-invented themselves yet again, packaging themselves as ETFs (exchange-traded funds) that trade daily just like actual stocks as opposed to the older mutual funds that are re-priced only once per day at the close and are not publicly traded.

ETFs may or may not be “actively managed,” i.e., traded by their respective managers for larger gains (or losses). “Indexed funds” are not actively managed but are maintained to keep an investment mix that closely matches the indexes to which they are linked.

CEFs (closed-end funds) are an older and rarer bird. They are generally fairly actively managed mutual funds but with one major difference: new shares are never (or rarely) issued. Hence, the term “closed-end” funds. As a result, unlike mutual funds, repriced daily at the close, CEFs also trade like stocks, just like ETFs, but with one major difference. Depending on supply and demand, they can trade at a premium or a discount to their actual net asset value, meaning that they can at times trade for more than their shares are worth, and at other times for less than they’re worth.

Of these three hybrid, yield-sensitive candidates, the Pimco Municipal Income fund (PMF) (-and the BlackRock Defined Opportunity Credit Trust (BHL) are (-2.3) closed end funds. PMF invests in municipal bonds, while BHL invests in a variety of regular and floating rate loans and other credit vehicles.

Given interest rate fears, the less conservative BHL is trading at a 2.3% discount to net asset value and is currently yielding a decent 4.63%, with dividends payable monthly. PMF, however, is trading at a hefty 14.44% premium, although still yielding a better than average 6.32% overall, with dividends again payable monthly.

Worried about PMF’s muni bond portfolio due to the current Puerto Rican muni bond crisis. Pimco has our collective backs on this one, currently noting on its website:

“We have long viewed the challenge facing Puerto Rico (PR) as a debt sustainability issue. This led us to sell the last position in PR debt in our dedicated municipal portfolios in the first quarter of 2013 at a premium dollar price. And today, firm wide, we maintain zero exposure to Puerto Rico credit risk.”

Both BHL and PMF are currently in recovery mode. But given that the Fed’s interest rate hiking schedule is likely to be fairly conservative, they may continue to stage a modest price recovery in 2016 while still offering those handsome yields.

Our third idea here, BKLN, is an actual ETF, an indexed fund that trades like a stock and invests in a portfolio of senior loans linked to an average known as the S&P/LSTA U.S. Leveraged Loan 100 Index. Its investments are relatively short-term instruments, which serve to insulate the ETF, at least somewhat, from heavy interest rate gyrations, since the portfolio is constantly if gradually refreshed. Like our pair of CEFs, BKLN also issues dividends monthly and is currently yielding 4.02% and trading at a very slight discount of -0.13%.

These surprise “bounce back” candidates are already recovering, but could continue to snap back in early 2016 given the clear overreaction to the Fed’s current policy that caused them to sell off. In the meantime, they offer decent and likely safe yields “While-U-Wait.”

As usual, no guarantees, of course. 2016 remains a mystery wrapped in an enigma.

Full disclosure: This writer currently owns shares of PMF.

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