!-- Global site tag (gtag.js) - Google Analytics -->
Select Page

The Weekly Summary

 

Another market holiday gives us time to reflect on what's become a great earnings season and a solid 2020 so far. While the S&P 500 as a whole faltered at the end of January, we haven't seen the coronavirus outbreak get in the way of the stock market here, nor the specific stocks we recommend. Most of the BMR universe has gained ground YTD. Our High Technology stocks are up 15% and the Aggressive group has soared 25%, but each of our seven thematic portfolios is in positive territory.

 

All in all, BMR stocks continue to outperform what's already a bullish market that looks to continue last year's rally. Only the Tech-heavy Nasdaq is within sight of our YTD performance, up 8% against our 9% return so far. Naturally many of our highest flyers are heavily weighted in the indices for good reason: they're moving fast to the upside, and growing, while less dynamic stocks are stalling or even shrinking.

 

Volatility continues to recede. Unless conditions in China are much worse than the epidemiologists currently believe, the impact on the global economy should be minimal. That will be good for Energy stocks and Technology Component manufacturers that have suffered in the shadow of what could still become a significant slowdown in Asian economies. We'll simply have to watch and wait. For now, our stocks clearly have the upper hand.

 

Gary Jefferson takes a look at the real market risks hiding behind coronavirus chatter and The Big Picture builds on last week's abstract discussion of earnings growth to focus on what we've seen from our recommendations. Then The High Yield Investor lays out our latest thoughts on a few names we haven't talked about in some time: BlackRock Income Trust and Invesco Municipal Trust, as well as Annaly.

 

There’s always a bull market here at The Bull Market Report! We have two earnings reports (Vornado and Agilent) to look at Tuesday night, so we're providing Previews here. Thursday will be busy in the already-truncated post-holiday week, but after that, our season is largely over, with only scattered reports over the remainder of the month. We're happy to go back and review a few of the biggest names of the season, including Amazon, Apple, Microsoft and Visa as well as PayPal. It's also a good time to check in on CBRE Group.

 

And look for a new Aggressive portfolio addition in the next 48 hours!

 

 

Key Market Indicators

 

 

-----------------------------------------------------------------------------

BMR Companies and Commentary

 

The Big Picture: BMR's Growth Advantage

 

We talked last week about the wonderful things the S&P 500's return to positive year-over-year earnings growth can do for the market mood. The "rising tide" of fundamental expansion can lift whole sectors, setting them on a virtuous cycle where swelling profit supports confidence and ultimately gives stocks room to break records. After all, if investors were willing to pay a given amount for every $1 in earnings in the past, increasing the size of the earnings pool each share represents justifies upside without bending historical limits one bit.

 

Admittedly 1% earnings growth for the S&P 500 is a step in the right direction after nearly a year of deterioration, but it's still on the sluggish side. For decades, the market's bottom line has climbed more than 6% in any typical year, giving stocks the fuel they needed to rally nearly twice as fast. On that basis, it might be another few quarters before the fundamentals really get hot enough to push the market.

 

However, investors love to anticipate future conditions and hate getting trapped on the sidelines watching stocks soar. With that in mind, there's nothing stopping the S&P 500 from moving fast now to capture what could become 10% earnings growth later this year. Either way, even a little uptick in earnings is far from a sell signal. At worst, slow growth justifies patience.

 

Our stocks are moving a lot faster than the market as a whole and even our own forecasts. Three months ago, BMR recommendations were tracking no-holds-barred 40% earnings growth for 4Q19 compared to 4Q18. Now, with most of our stocks on the record with their numbers, we're looking at closer to 60% growth. That's huge. Compare it to anemic movement for the S&P 500 as a whole and it's completely spectacular.

 

Of course not all of our stocks are boosting their profit anywhere near 60%. A minority (about 15% of our universe) is locked out of the comparisons because the math just doesn't match. If a company lost money in 4Q18 and is still losing money, or even if it has flipped from loss to profit, there's no clear percentage to feed into the calculations without distorting every other stock's performance. Likewise, when a company flips from profit to loss, it's a special case that would overwhelm everything else.

 

We've run the numbers a lot of different ways and this one presents the clearest view of what's going on in our universe. And there are always special cases that are so good that they skew the average too much to be useful. This quarter, for example, we predicted that profit at Blackstone Group (BX) swelled a full 1,200% from a miserable $0.05 to a healthy $0.68. We got 1,300% growth instead. If you think those windfall numbers obscure what's going on with our other stocks, just leave it out of your math . . . and you're still left with 20% growth across the BMR universe.

 

This is why we love these stocks and aren't content to sit back with an S&P 500 index fund. Whatever fundamental headroom the index fund has to work with now, our stocks collectively have 20X as much, even after you cut Blackstone out of the mix for argument's sake. From what history tells us, 6% growth can push stocks about 11%. With that in mind, our 20% growth trend bodes well for the future.

 

And the real thrill here is the way BMR stocks are outperforming by both beating already bullish expectations and, in the case of companies facing tough year-over-year comparisons, not doing as poorly as we suspected. Giants like Facebook and Apple squeezed a few extra percentage points of growth out of the quarter. Others like Microsoft and Amazon turned what initially looked like declining year-over-year numbers into real growth as well. Only two of our stocks so far have truly disappointed on earnings: Twitter and AstraZeneca. Twitter rallied. We have faith AstraZeneca will as well.

 

-----------------------------------------------------------------------------

 

Amazon (AMZN: $2,135, up 3% last week)

 

Amazon is part of an exclusive group, the trillion-dollar club. The wealth created by owning the stock over the years has been spectacular. In just the last five years, it has shot up nearly 5x times, from $380, reaching an all-time high of $2185 earlier last week.

 

The company is so successful that it can change a whole industry when it decides to enter the field (e.g. grocery). Amazon has revamped Retail and completely changed the way it works. Companies are still trying to catch up by strengthening their online capabilities.

 

According to Amazon, “We seek to be Earth’s most customer-centric company. We are guided by four principles: customer obsession rather than competitor focus, passion for invention, commitment to operational excellence, and long-term thinking.” Can anyone argue that the company hasn’t accomplished what it set out to do? For that matter, no one will quarrel with the results, either.

 

Remember when the company was investing in different areas (Amazon was originally only a bookseller), growing sales but lacking profitability? Those days are long gone. Sales more than doubled from 2015’s $107 billion to $280 billion last year. During that time period, income went from $600 million to $11.6 billion. This profitability has translated into ever-increasing cash flow. In 2019, Amazon generated $38.5 billion in cash, up 25% from 2018’s $30.7 billion.

 

BMR Take: No one wants to compete with Amazon. A dominant company, it still invests in growth. We expect Amazon to continue generating revenue growth from areas such as Amazon Prime (with its access to free delivery, movies, books, and more), online grocery delivery, and Amazon Web Services, the online cloud computing platform, not to mention Alexa. Amazon is approaching our $2,200 Target Price. Once it crosses that threshold, we anticipate raising it. Our Sell Price? We don’t have one. Why would we think about selling such a wonderful company that continues to innovate, enter new markets, and succeed on such a large scale? We wouldn’t.

 

 

 

-----------------------------------------------------------------------------

 

Apple (AAPL: $325, up 2%)

 

Like Amazon, Apple is another $1 trillion market cap that has reached new heights. The stock is within a whisker of the all-time high ($328) reached on February 6. We don’t think anyone would complain about a 90% gain in a year.

 

The company produces “cool” products and gadgets. Any doubt about its latest products’ prospects should have been erased with Apple’s fiscal 1Q20 (ended December 28, 2019) report. Sales grew to $92 billion compared to 1Q19’s $84 billion, or a 9% year-over-year increase. Income rose an even better 11%, from $20 billion to $22 billion. Thanks to share buybacks, EPS was 19% higher, rising to $5.00.

 

Apple’s iPhones, the biggest source of sales (61%) led the way. Strong demand from its latest iPhone 11 models fueled the sales increase to $56 billion in the latest period versus $52 billion in the year-ago period. The next two largest categories, Services (14% of sales) and Wearables, Home and Accessories (11% of sales) also experienced strong growth of 17% and 37%, respectively.

 

The numbers don’t lie. The company has built a loyal customer base, and they are certainly not tired of Apple’s offerings.

 

Apple generates a mountain of cash flow. In just 1Q20, operating cash flow was $30.5 billion compared to 1Q19’s $26.7 billion. This allows the company to return some of this to shareholders. First, it buys back shares, including $20.7 billion in 1Q20, way more than double 1Q19’s $8.8 billion. Second, Apple pays a steadily increasing dividend.

 

BMR Take: For those that were wondering whether Apple could continue producing innovative products that gain acceptance in the marketplace, the answer is clearly yes it can. A company as large as Apple still growing profits by double digits is not easy to find. For that reason, we simply would not sell Apple, with its continuous product introductions and loyal following. Our Target Price is $375.

 

 

-----------------------------------------------------------------------------

 

CBRE Group (CBRE: $64, flat)

 

It is hard to believe that 11 years ago CBRE hit an all-time low of $2.50. Fast forward to today, and the stock hit an all-time high last week before dipping a dollar. The last year was nothing to sneeze at, either, with a 30% gain.

 

CBRE has grown into a Commercial Real Estate powerhouse. It has shown remarkable staying power, with its founding back to 1906. In this competitive industry, the company has not only survived – it has thrived. CBRE is the largest Commercial Real Estate services and investment firm when measured by revenue.

 

It provides services to occupiers (sales/leasing, facilities management) and investors (sales, mortgage brokerage, loan origination, leasing, property management, valuation). CBRE generates management fees, which are steady and fairly predictable, and commissions. Its operations are also diversified geographically, serving clients in over 100 countries.

 

For 9M19, revenue rose by 11% year-over-year, from $15 billion to $16.8 billion. We are not concerned that profit fell from $670 million to $650 since this was caused by lower “other” income and lower gains from Real Estate Investments than a year ago. The company is scheduled to report 4Q19 results on February 27, before the market opens. We'll provide a Preview a day or two in advance.

 

BMR Take: CBRE’s large size is a competitive advantage, putting the company in a position to win contracts while its size results in economies of scale. It holds the #1 position in leasing, property sales, outsourcing, property management, and valuation. Its client list includes virtually the entire Fortune 100. As a part of the S&P 500, index funds must hold it. CBRE has surpassed our $60 Target Price. Our faith in the company’s prospects has not wavered. Therefore, we are raising our Target Price to $71. Our $44 Sell Price is now raised to $56.

 

 

-----------------------------------------------------------------------------

 

Microsoft (MSFT: $185, up 1%)

 

This is the third trillion-dollar market cap company we are writing about today, making it understandable if investors get lulled into thinking this is a common occurrence. The fact is, these are very rare and reaching this milestone is a cause for celebration. Over the last nine years, the stock has increased 9-fold. Earlier this month, Microsoft hit $189, an all-time high. The past year was good for shareholders, with a 75% gain. Since Microsoft reported fiscal 2Q20 (ended December 31, 2019) results at the end of January, the stock is up from $165.

 

There is a lot to like here. Everyone has heard about the company’s popular product offerings – its Office suite and Windows operating system. But the company is much more than that, which is why Microsoft’s future is bright.

 

For starters, the company bought LinkedIn, a major professional networking site, a few years ago. And there is Microsoft’s tremendous gaming business, encompassing Xbox hardware and games, and devices such as Surface.

 

Microsoft is not done investing in the future. It is looking to help customers with the digital transformation, including opportunities in AI and intelligent cloud as well as evolving the gaming experience. Management noted AI’s vast potential in Healthcare, in particular.

 

Now, about those 2Q20 results. Revenue rose 14% year-over-year, from $32.5 billion to $36.9 billion. They spent more on R&D ($4.6 billion versus $4.1 billion), as well as Sales & Marketing ($4.9 billion versus $4.6 billion). This did not stop the company from growing profits from $8.4 billion to $11.6 billion. Outstanding. Astounding!

 

These profits translate into a ton of cash flow. In just the last two quarters its operating cash flow was $24.5 billion, a 9% increase from the year before. It puts this cash to good use, spending $10.1 billion on buybacks and annually increasing dividends (1.1% yield). At the same time, management has also been paying down debt. There is $135 billion in cash and $90 billion in debt.

 

BMR Take: Investors that believe Microsoft has turned into a stodgy, boring, even outdated company are missing the boat. Our strong positive feelings about the company are reflected in our $200 Target Price and the fact that we do not have a Sell Price since we envision owning this company for a long time to come.

 

 

-----------------------------------------------------------------------------

 

PayPal (PYPL: $123, up 3%)

 

PayPal closed at a record high on Friday, eclipsing the previous all-time high of $121 record high reached in late-July. Subsequently, the stock dropped to $97 four months ago before going on a run. There were some that raised concerns about slowing growth after the company reported 2Q19 results. These were just fine, by the way. Revenue grew 11% versus 2Q18, from $3.9 billion to $4.3 billion and profits were up 56%, from $525 million to $825 million. The Street didn’t like that management lowered 2019 revenue guidance to $17.7 billion compared to their previous $18 billion.

 

When PayPal reported 4Q19 results at the end of January, it met the revised figure. We are more than OK with 15% year-over-year revenue growth. Management mentioned that they expected to recoup the lost 2019 revenue since it was delayed and not lost. Income was $2.5 billion compared to 2018’s $2.1 billion.

 

With more payments made digitally, PayPal, with its leading position, is in prime position to continue benefiting. They offer its core PayPal product and Venmo, which appeals to a younger clientele, and a credit card. These solutions connect merchants with consumers to transact and complete payments. There are 305 million active accounts (14% higher than in 2018) across 200 markets.

 

Management’s 2020 guidance looks good to us, too. They are looking for 18% revenue growth to $21 billion. Earnings per share are expected to fall to $1.90 from $2.07 due to acquisitions, including a negative tax effect from the Honey deal.

 

BMR Take: PayPal faces a couple of competitors, but it is the leader in payment processing. With a rapidly expanding market, we believe there is room for all of the companies to co-exist, making PayPal a must-own stock. We look for more upside, reflected in our $140 Target Price. Our confidence in the company is high. Hence, we do not have a Sell Price.

 

 

-----------------------------------------------------------------------------

 

Visa (V: $210, up 4%)

 

Visa is yet another company trading at record heights after reaching $210 on Friday. In the last year, the stock is up 47%. This is even more impressive when you consider Visa is a six-decade-old company, a time when many companies enter the mature phase that is categorized by slower growth. That is hardly the case here. Visa is a leader in digital payments, facilitating transactions around the world between consumers and businesses through its secure and reliable payments network.

 

Last year, Visa concentrated on growing digital payments utilizing the advancement of technology, including mobile and 5G networks. To capitalize, management is focused on investing in its core business, which is credit, debit, and prepaid cards. There is a huge opportunity for Visa to convert the $17 trillion in consumer spending and $20 trillion in business-to-business spending done in cash and checks.

 

Revenue and earnings continued to grow in fiscal 1Q20 (ended December 31, 2019). Quarterly revenue and profits both increased by 10% compared to 1Q19. The top-line was $6.1 billion versus $5.5 billion and income rose from $3.0 billion to $3.3 billion.

 

Last month, management announced a deal to acquire Plaid, a leading technology provider that connects consumers with financial technology (fintech), for $5.3 billion. Although initially dilutive to EPS, the acquisition will provide longer-term benefits. Plaid is a dominant player in the industry, with 75% of fintech providers using its solutions to connect with consumers’ financial institutions (e.g. bank and brokerage accounts). Plaid is used by financial apps such as Acorns, Betterment, Venmo, and many of the largest banks that make it convenient for consumers to connect their financial accounts with the app of choice.

 

BMR Take: Visa’s size and established market position make it tough on competitors. There simply aren’t many companies that can keep up with Visa. The tailwinds at their back are strong and sustained, moving the stock in the right direction. After reporting 1Q20 results, we raised our Target Price from $200 to $230. Our Sell Price? We wouldn’t think of selling Visa.

 

 

-----------------------------------------------------------------------------

 

A Word From Gary Jefferson

Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.

 

News on the virus will remain the focus of traders' attention for another few days. While traders had hoped to see the contagion flattening two weeks after the Wuhan quarantine began on January 23, Chinese authorities said the flattening may not occur until two weeks after February 7. That means another week of probable volatility.  We suspect the market will gravitate toward the three most likely challenges we'll face later this year: trade talks getting off track, the U.S. election and the global business cycle turning back down.

 

Start with the economy. The blowout January jobs report was a fitting way to cap off a cycle of economic numbers that started with better than expected manufacturing results, then construction spending, then retail sales, motor vehicle sales, factory orders, mortgage applications, service industry gains, and of course jobs! The industries with the biggest job gains came from the Construction industry with 44,000 new jobs created, Healthcare with 36,000 new jobs, Leisure and Hospitality also with 36,000 new jobs, Transportation and Warehousing with 28,000 new jobs and Professional and Business Services with 21,000 new jobs created.

 

What’s especially good about the Jobs report is the dominance of private sector jobs versus the small percentage of “government” ones.  These number were the reverse during the eight years of the prior administration, when government job creation was more often than not growing much faster than private. Another problem with that was that government ended up growing much faster than incomes.

 

Worse, when it comes to stimulating the economy and creating real wealth, private business is a race horse while government is a "dead horse."  For all those years the race horse had to drag the dead horse and that’s why we had a “plow horse” economy for so long. There was growth, but it was the slowest growth of the past 50 years. For the past three years we have seen private business leap to the forefront in job creation and the result is the best economy in the world. The formula is as simple as 1+1=2. When you resist the urge to harness the private business race horse to a government dead horse, investors will win the race every time.

 

As for the other two risk factors, the only one of the three suggested challenges that really concerns us is the U.S. election resulting in a renewed “government” growth cycle. Fortunately, we don’t see it as something likely to happen at this juncture in the political landscape. Otherwise, private business (entrepreneurialism), a strong economy and an accommodating Fed should be able to weather trade issues and global market cycles without too much disruption. The coming benefits from already inked trade deals, continuing low taxes and interest rates, along with fewer regulations, provide a huge safety net supporting our economy.

 

-----------------------------------------------------------------------------

 

Earnings Preview: Agilent Technologies (A: $86, up 3%)

Earnings Date: Tuesday, 5:00 PM ET 

Expectations: 4Q19
Revenue: $1.35 billion
Net Profit: $254 million
EPS: $0.81

 

Year Ago Quarter Results
Revenue: $1.28 billion

Net Profit: $244 million
EPS: $0.76

 

Implied Revenue Growth: 5%
Implied EPS Growth: 6%

 

Target: $100 
Sell Price: $74
Date Added: December 16, 2019
BMR Performance: 2%

 

Key Things To Watch For in the Quarter

 

Slow and steady is the key to this company. Agilent never tries to rock the boat. They don't take on the risk and expense of funding expensive drug development programs on their own. Instead, they have spent the last five years building global franchises in Diagnostics, Genetic Testing and other Laboratory Services . . . instead of making the drugs, they deploy their expertise on behalf of the drug companies and get paid either way. The business model literally pays dividends and is even accelerating a little.

 

This quarter will be the "slow" one based on guidance and then later this year we expect revenue to pick up significantly. Again, it's less about a steep ramp than it is about reliability. Agilent may not grow fast for a little while but it is unlikely to backslide either. The road points up. It's only the speed that's in doubt. Our near-term revenue target may even be a little low.

 

-----------------------------------------------------------------------------

 

Earnings Preview: Vornado (VNO: $68, up 3%)

Earnings Date: Tuesday, 5:00 PM ET 

Expectations: 4Q19
Revenue: $457 million
Net Profit: $110 million
EPS: $0.83
Funds From Operations: $1.57

 

Year Ago Quarter Results
Revenue: $543 million

Net Profit: $51 million
EPS: $0.34
Funds From Operations: $1.10

 

Implied Revenue Decline: 16%
Implied EPS Growth: 145%
Implied FFO Growth: 42%

 

Target: $80 
Sell Price: $50
Date Added: March 5, 2018
BMR Performance: 13%

 

Key Things To Watch For in the Quarter

 

We often say Real Estate obeys different investment math from the rest of the market. Vornado this quarter will be all the proof of that we need. The company has slimmed down over the past year, selling close to $2 billion in property in order to focus on core operations and to raise cash to develop massive New York City projects. In the meantime, it's no wonder the buildings' new owners are cashing the rent checks instead, depressing Vornado's year-over-year revenue.

 

However, the buildings left behind are significantly more profitable, boosting both earnings and Funds From Operations (the most important number we look at) even though the top line has dropped. While earnings in Real Estate are often a figment of the accountants' creativity, this quarter promises to be more arbitrary than usual . . . triple-digit earnings growth despite a double-digit revenue decline isn't something to count on as the new status quo here. Extreme earnings expansion can continue for a quarter or two but by the end of the year we expect the comparisons to flatten out again. The long term looks good, but the short term will always be noisy when it comes to REIT earnings.

 

Funds From Operations, on the other hand, is practically a sacred thing for Real Estate accountants. This is the pool of cash that feeds dividends. Anything above $0.66 every three months maintains the current 3.9% yield. We're confident that Vornado will give us at least $0.85 a quarter throughout 2020. This leaves the door wide open for bigger payouts to come.

 

 

-----------------------------------------------------------------------------

The High Yield Investor

 

The bond market once again took its cues from the stock market, which is ebbing and flowing from news about the coronavirus, alternating between positive and negative news. This is also earnings season, and Apple, Amazon and Microsoft, three of our favorites, all reported excellent results. The economic data shows a growing economy that is not overheating. The Jobs report was positive, showing 225,000 newly created jobs and increased participation, both positive signs. Last week, the Commerce Department’s Retail Sales report showed a 0.3% increase, led by home centers and restaurants.

 

We heard from Jerome Powell, Federal Reserve Chairman, testifying before Congress last week. Coming on the heels of an Open Market Committee meeting, there weren’t any surprises. He discussed the economy’s growth chugging along and the low unemployment and inflation rates. The Fed is also closely monitoring the coronavirus situation and its impact on the global economy.

 

For the week, yields were flat across the curve. The two-year yield inched up to 1.42% while the 10-year yield was flat, at 1.59%. This translates into a 2-10 spread of 17 basis points, narrowing by one basis point. We monitor this spread for signs that it is inverting, a potential signal that the economy is heading into a recession. Based on our reading of the economic situation we find no such risk.

 

We forecast that interest rates will stay range-bound for the foreseeable future. The Bull Market Report continues to analyze investments for yield hunters with different risk tolerances. Annaly Capital Management is for investors willing to take more risk, paying investors 800 basis points above the 10-year Treasury yield. The company’s results are dependent on earning a spread between its short-term borrowings and investments.

 

Those more conservative investors should look at the other two names we discuss. BlackRock Income Trust, which invests in highly rated mortgage-backed securities, has more than a 500-basis point yield advantage over the Treasury. Invesco Municipal Trust seeks high-quality municipal bond investments. The 300-basis point current yield advantage doesn’t tell the full story since municipal bond interest is exempt from federal income taxes.

 

Annaly Capital Management (NLY: $10.42, up 4%, yield = 9.6%)

 

Annaly is a REIT that invests in residential and commercial assets, separated into four groups. These are Agency, Residential Credit, Commercial Real Estate, and Middle Market Lending.

 

Agency holds mortgage-backed (MBS) and commercial mortgage-backed securities (CMBS) issued by Freddie Mac, Fannie Mae, and Ginnie Mae, among other securities. Residential Credit buys residential mortgage loans or MBS that are not guaranteed by the aforementioned agencies. Commercial Real Estate buys commercial loans and CMBS, which both use commercial real estate as the collateral, along with mezzanine loans (collateralized by commercial real estate but subordinate to first-lien debt), and commercial real estate. Middle Market Lending Group purchases first lien and second lien loans made to smaller companies.

 

Annaly is sensitive to interest rates since it earns interest income on its investments and pays interest expense on borrowings. The difference is the net interest income. This rebounded to $455 million in 4Q19 versus 4Q18’s $270 million. The bottom line flipped to a $1.2 billion profit from a $2.3 billion loss.

 

The company borrows at the short end of the Treasury curve and buys securities with longer-term maturities. So, the spread between short rates and long rates is important to revenue and profitability. The curve has flattened, hurting their results a bit. If this continues or even inverts, this would turn into a worsening situation for the company. This is a risk that investors should know ahead of time.

 

Annaly Capital Management (Target Price: $11, Sell Price $9.50) offers a high 9.6% yield, which is attractive in this low-rate environment. Obviously, this requires a higher risk tolerance. Dividends have been a steady $0.25 for the last three quarters, down from $0.30 a year ago. In the last recession, the payout was much higher, providing some defensive characteristics.

 

 

BlackRock Income Trust (BKT: $6.11, down 1%, yield=6.8%)

 

We have a closed-end fund here that was launched more than three decades ago. Its investments are conservative with the twin goals of preserving capital and earning monthly income. The managers do this by investing most of the assets in mortgage-backed securities (MBS). The Trust’s mandate is to invest at least 65% of its assets in MBS. 80% of the assets must be in securities issued or guaranteed by the U.S. government or one of the agencies, or rated AAA. In actuality, virtually all of their assets are in these highly rated securities. The biggest portion, one-third, is invested in Fannie Mae securities.

 

MBS are a pool of residential mortgage loans created when a bank puts a bunch of them together and then a government-sponsored agency (e.g. Ginnie Mae, Fannie Mae, or Freddie Mac) creates the pool and guarantees the principal and interest payments to MBS investors. This provides a measure of security since the US government is backing the payments.

 

Since this is a closed-end fund, it trades like a stock, which may reflect a discount or premium to the trust’s net asset value (NAV). At $6.11, it is at a slight discount to the $6.36 NAV. Over the last several years, the company has beaten its benchmark FTSE Mortgage Index by 1-2%.

 

BlackRock Income Trust (Target Price: $6.50) is for the more conservative investor. It provides a 6.8% yield, which is well above the 10-year Treasury yield to compensate for the extra risk. Fannie Mae and Freddie Mac have always had the “implicit” guarantee of the U.S. government, and that concept was tested and proven during the last economic downturn more than a decade ago.

 

 

Invesco Municipal Trust (VKQ: $12.84, down 1%, yield = 4.6%)

 

Another closed-end fund, this one set up to provide federally tax-exempt current income while preserving capital. Investors should know that municipal debt is not the same as buying federal debt. U.S. government securities are considered risk free. Municipalities can and have filed bankruptcy (e.g. Detroit, San Bernardino, Stockton and Vallejo in California), meaning there is risk involved.

 

Invesco offsets this risk by investing most of the portfolio’s assets in AA and single-A rated bonds. The breakdown is 5% in AAA-rated bonds with 30% and 28% invested in AA-and A-rated bonds, respectively. Investments in BBB-rated bonds were 20% of the assets. Below investment-grade investments are a combined 7% and non-rated bonds were 10%.

 

There are five states that represented 45% of the portfolio. Illinois was the largest, at 12%, followed by Texas, New York, New Jersey, and California. The Trust makes distributions monthly.

 

Invesco Municipal Trust has a Target Price of $15. The 4.6% yield is misleading since the income is not taxed by the U.S. government. To make the comparisons apples-to-apples, you need to compare the yield to what you would have to get if it were taxable, also called the tax-equivalent yield. This is simply the yield, in this case, 4.6%, divided by 1 minus your federal tax rate. If you are in the 37% tax bracket, the tax-equivalent yield is 7.3%. Let’s say you are in the 10% tax bracket. Then, your tax-equivalent yield is only 5.1%. As we are sure you are aware, municipal bonds are most beneficial to wealthier investors in higher income tax brackets.

 

 

 

Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998