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To say the market has been "moody" as of late
would be an understatement.
From its low in March 2009, the S&P 500 gained +80% before
reaching its peak more than a year later. And now, in about
a month, it's dropped -13% -- that includes the May 6th
debacle that saw the Dow drop -10% at one point in the day.
All of this has made the Volatility Index -- a measure of
volatility and thus, fear, in the markets -- triple since
April. Confidence is in short supply.
We'd all love to see a constant bull market. (Wouldn't that
make retirement easier?) But as investors, you have to take
the good with the bad. And the good news for us is that
downturns -- especially those that are really sharp -- are a
breeding ground for choice opportunities and high yields.
And if we see a sudden sell-off, I'm ready for it.
I saw what happened in previous downturns, and I know
exactly what I'm looking for: Closed-end funds trading at
unnaturally big discounts to their
net asset values (NAVs).
Unlike open-ended mutual funds, closed-end funds don't trade
at their net asset values -- the value of their underlying
holdings. Instead, the funds trade throughout the day at
whatever price the market decides they are worth. As a
result, they can often trade at a premium or a discount to
the value of their actual portfolios.
When panic reigns, closed-end funds can be so oversold they
start to trade at huge discounts -- when you can
literally pick them up for 60 cents on the dollar. The
sharp drops also give you an opportunity to lock in some
unprecedented yields.
But you have to move quickly. These massive discounts and
yields don't last long before investors jump on the bargain
they represent. You may get a few days. If you're lucky, you
may get a week before the discounts start to close again.
To illustrate the power of these temporary discounts,
look at these examples from previous sell-offs:
|
Ticker |
Start Date |
Discount |
Yield |
1-Wk. Return |
|
EVT |
11/21/08 |
-28.8% |
15.0% |
+29.9% |
|
ERC |
10/10/08 |
-40.3% |
17.4% |
+33.1% |
|
CGO |
10/9/08 |
-38.7% |
18.9% |
+25.0% |
This is just a sample. Dozens of closed-end
funds have experienced the same phenomenon -- sharp
sell-offs followed by dramatic recoveries as their discounts
were bought up by eagle-eyed investors.
Since these sorts of moves happen so quickly, however,
you've got to prepared ahead of time. Not only do you need
cash at the ready, you also need to have a shopping list in
hand.
You don't want to just buy a fund for the discount. In the
event that discounts are slow to narrow, you still want to
have the satisfaction -- and eventual benefit -- of picking
up a solid holding at a large discount.
No one really wants a market correction. I think we'd all
like to see a full-blown economic recovery and a
continuation of the rally. But we have to take what the
market gives us. That's why you should always have a plan at
the ready to profit from a sharp pullback.
Always searching for your
next paycheck,
Amy Calistri
Chief Investment Strategist --
The Daily Paycheck
P.S. -- If you're interested in learning more about
The Daily Paycheck, please
visit this link. I'd love for you to join me as I
continue building my portfolio! |
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