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Junk Bonds: Time To Start Accumulating – Yield Over 21%

Summary Overselling mostly done in the junk bond space. I am buying for my retirement portfolio: CEFL – over 21% yield. Components of CEFL are trading at heavy discounts, and the security is on the rebound. CEFL: An opportunistic buy. Following my latest article on my high-yield “Model Retirement Portfolio” (6% Dividend Target) published Monday (December 14) on Seeking Alpha, recommending dividend investors to start buying the UBS ETRACS Wells Fargo Business Development Company ETN (NYSEARCA: BDCS ), the shares of the ETN have rallied around 3%. I believe there is much more upside to come, as the sector is still oversold with no real merit. If you have not started to buy, it is not too late. For those who have opted to buy the leveraged version, the UBS ETRACS 2X Leveraged Long Wells Fargo Business Development Company ETN (NYSEARCA: BDCL ), the shares closed over 6% up since Monday. I promised in my Monday article to give an update on the best time to start accumulating on junk bonds. Well, the time has come! I will provide guidance on the best approach. Update on the Junk market space The sector recently experienced heavy losses and a meltdown , leading to heavy redemptions by investors. This was sparked by rock-bottom levels of risk tolerance, persistent downside risk to commodity prices, and turmoil in emerging markets. However, recent comments from high profile investment banks have calmed down the markets: UBS (NYSE: UBS ) reported last Monday: Junk bonds sell off, oil drop worries are overdone. The Chief Investment Officer at Guggenheim Partners stated: There is a “buy” signal for junk bonds. A Goldman analyst stated that investors are being too pessimistic . BlackRock’s Senior Director stated on Monday that junk bonds won’t spark a new crisis. It will be contained. Tracking this sector, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ) both ended the week with returns (before dividends) of 1.66% and -0.18%, respectively, during the last 5 trading sessions. This is despite heavy losses for the week sustained in all the major indexes. So it looks like we are close to a bottom. Best way to enter the Junk Bond Space To be prudent, I am not investing directly into the junk market ETFs. I am investing with a much more balanced approach using the UBS ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA: CEFL ), a leveraged Exchange Traded Note issued by UBS with a stated yield of over 26%. What exactly is CEFL? CEFL is a fund of “closed-end funds” (basically a fund of funds) issued by UBS. It comes in the form of an exchange-traded note (ETN) linked to the monthly compounded 2x leveraged performance of the ISE High Income index. Its objective is to capture the top 30 closed-end funds as determined by a ranking scheme, allowing investors to take advantage of both event-driven news and long-term trends of the U.S. closed-end fund marketplace. The note is leveraged, so it pays approximately twice the yield of the related index, which comes with a stated yield of 21.78% ( UBS ). The dividend is paid monthly via a variable monthly coupon. CEFL’s top ten components (making up 45% of total holdings) are depicted in the following table, which includes the weight of the security and the discount to net asset value (NAV) and return of capital for 2015. (click to enlarge) Advantages of Investing in CEFL Now: CEFL is not a pure junk bond play. It is a very diversified product which includes, among others, preferred shares, mortgage backed securities, corporate bonds, junk bonds, emerging market bonds, foreign government bonds, investment grade corporate bonds, high yield corporate bonds, and even certain stocks. It offers one of the most diversified ways to invest in the high-yield bond space, as it is basically a “fund of funds”. The security has been selling off since the beginning of the year, both from worries of higher interest rates and from the junk bond crisis. The shares have lost, after dividends, over 17% of their value. Signs of life and rallying the past week: CEFL is up 5.8% during the last 5 trading sessions. This is despite the heavy losses sustained in all the indexes. The S&P (NYSEARCA: SPY ) was down about 1.2%, while the Dow Jones Index (NYSEARCA: DIA ) was down 1.4%. It is a good time to catch them on the way up. CEFL components are still trading at a heavy discount to net asset value. As seen on the table above, the average discount of its 10 top components is 13.1%. So this security is on fire sale. CEFL provides exposure to emerging markets through its bond portfolio. With certain analysts predicting that emerging markets will start recovering in 2016 and 2017, along with the prices of commodities, CEFL will benefit from such a recovery. Several investment bankers, including Goldman, Guggenheim, UBS, and BlackRock, have just started being optimistic. Now that the fears of high rate increase by the Fed have started to dissipate (only 0.25% hike and prudent approach to future hikes), I expect the security to do well in the short and medium term. Other Important Information on CEFL: Not all the stated 21.78% yield is actual dividend. Part of it is a return of capital as some of these funds had to return part of the investment to their shareholders in order to maintain yield. If we have a look at the table above, the average “return of capital” for the 10 largest holdings is 15.3% for the year 2015 (to-date). If we assume the same percentage for all the securities, that will give CEFL an effective yield of 18.4%. CEFL’s dividend is also variable. The security of CEFL is twice leveraged. So any price movement in the underlying securities will have a double effect. Expect volatility, but do not worry much, the fundamentals are good. It may be wise to spread small purchases during a period of one week. Try to average down during down days. Conservative Diversification Please note that I use conservative diversification to protect my “high dividend portfolio”. I have started buying CEFL but will only allocate around 3% of my total portfolio to the security, especially due to the leverage effect. I advise investors to also take a prudent approach. For this investment, I am happy to get a dividend of over 20%, which means in 5 years, I should have all my capital back and the rest is pure earnings generating additional income. Get alerts for “My Model High-Yield Retirement Portfolio” (6% Dividend Target) I am currently sharing future opportunistic additions to my “Model Retirement Portfolio” (6% Dividend Target), for which I often use ETFs and CEFs to protect my “egg nest” against volatility and against the risk of investing in a single security. Furthermore, my conservative strategy includes scrutinizing and generally avoiding excessively high dividend securities, which may lead to disproportionate risk taking and heavy losses. My target is to have a conservative and well-balanced high-yielding 6% dividend portfolio to generate long lasting income and protect against inflation. Please follow me if you are looking for dividend safety, diversification, and sound investment ideas.

The Dow 30, Volatility And The Validity Of A Filter

When the market corrected in late August, a review of how the DJIA fared prompted me to establish a filter for my investment club to use when considering volatility. The criteria established identified six components for investment consideration. Five months of volatility later and with a new year on the horizon, it is an opportune time to review results. Running the same filter yielded both commonality and difference. Regardless, it reestablished a starting point for 2016. After the August 24th runaway decline (considered by many a correction) in the market, I looked at the DJIA to determine the most attractive 20% of the thirty for my investment club to consider. The criteria for the designation of “most attractive” was designed to both meet club goals and to ascertain the stocks that seemed to best withstand the volatility of the correction. The exercise was not meant to analyze each company or stock but, rather, was designed to establish a starting point for analysis. The factors designed to narrow the field included (and are discussed in more detail in the linked article above): The 50-day moving average could not be more than 25% off its 52-week high; Assuming a correction implies at least a 10% decline, the price must have decreased at least 10%; The price could not have recovered to within 10% of its 52-week high; The price had to bounce or recover at least 50% from August 24th lows; and The company must offer a yield of at least half the DJIA’s average dividend yield. The criteria eliminated seventeen members of the index. The remaining thirteen members were ordered based on potential return. Potential return was derived based on the growth left between current pricing and the lower (to be conservative) of either the 52-week high or analysts’ average one-year target and then added to the annual dividend yield. Interestingly, the club already owned the top four of the sorted remaining thirteen, Proctor & Gamble (NYSE: PG ), Boeing (NYSE: BA ), Apple (NASDAQ: AAPL ) and Cisco (NASDAQ: CSCO ). Buy points on the next six companies were established using a desired 20% gain as a goal. The results were: Component Buy Point 52-Week High or One-Year Target Potential Growth Dividend Potential Total Return JNJ $93.74 $109.49 16.80% 3.20% 20.00% MRK $54.51 $63.62 16.71% 3.30% 20.01% GE $24.66 $28.68 16.30% 3.73% 20.03% KO $38.60 $45.00 16.58% 3.42% 20.00% MMM $140.34 $164.31 17.08% 2.92% 20.00% MSFT $42.74 $50.05 17.10% 2.90% 20.00% What Now? After four months of volatility and with a new year on the horizon, it seems an appropriate time to review the filter. As well, one savvy SA follower suggested: “My guess is if you run this exercise again in a couple of months you’ll get a entirely different answer.” What did investments in the six on the August list return? Would the six still make the cut? Was the criteria used in August effective in determining volatility resistance? Which components would comprise the list for potential investments in 2016? Current Returns The next table displays the returns on the six components from the August list as well as the four companies the club already owned. It was prudent to consider whether a reinvestment was a better option than a new investment. For this exercise, the assumption is that each of the six components was purchased with a limit order at its buy point. On the four stocks already owned, the assumption is the reinvestment occurred at market open August 31st. Component Purchase Date Buy Point December 18th Closing Price Dividends Paid Since Purchase Current Return PG 08/31/15 $71.00 $78.13 $0.66 10.97% BA 08/31/15 $132.37 $139.58 $0.91 6.13% AAPL 08/31/15 $112.03 $106.03 $0.52 -4.89% CSCO 08/31/15 $25.94 $26.27 $0.21 2.08% JNJ 08/31/15 $93.74 $101.95 $0.75 9.56% MRK 08/31/15 $54.51 $51.64 $0.91 -3.60% GE 08/31/15 $24.66 $30.28 $0.23 23.72% KO 09/01/15 $38.60 $42.50 $0.66 11.81% MMM 09/01/15 $140.34 $146.92 $1.03 5.42% MSFT 09/01/15 $42.74 $54.13 $0.36 27.49% As shown, only two of the ten components had a negative return. The DJIA, as a whole, returned 3.63% from August 31st to December 18th. So, seven of the ten filtered components delivered returns better than the index average. Yet, of the top five performers in the index for the time frame, only two are on the list above – General Electric (NYSE: GE ) and Microsoft (NASDAQ: MSFT ). Home Depot (NYSE: HD ), Intel (NASDAQ: INTC ) and Nike (NYSE: NKE ), the remaining three of the five top-performing companies, delivered returns over 36% from the August 24th lows. The New Cut If the same filters are applied to the index based on the closing prices of December 18th, the results do vary. Using the criteria that a stock’s 50-day moving average can not be more than 25% off its 52-week high eliminates Chevron (NYSE: CVX ), IBM (NYSE: IBM ), United Technologies (NYSE: UTX ), Caterpillar (NYSE: CAT ), American Express (NYSE: AXP ) and Wal1Mart (NYSE: WMT ). The second criteria requiring at least a 10% decrease to warrant a correction originally eliminated American Express and Traveler’s (NYSE: TRV ). Traveler’s 52-week low occurred on August 24th. Therefore, using the “correction” definition, the stock has still not “officially” corrected from the August 21st closing price. The third filter eliminates stocks within 10% of their 52-week high. In this iteration of applying the filters, ten stocks are benched – JPMorgan Chase (NYSE: JPM ), United Healthcare (NYSE: UNH ), Visa (NYSE: V ), Johnson & Johnson (NYSE: JNJ ), Nike, Microsoft, Home Depot, Coca Cola (NYSE: KO ), General Electric, and McDonald’s (NYSE: MCD ). Applying the fourth filter of requiring the stock to bounce from its low to within at least 50% of its 50-day moving average eliminated Goldman Sachs (NYSE: GS ). The fifth criteria, a dividend yield greater than the average for the index, eliminates only Disney (NYSE: DIS ) from the remainder. There are eleven components now making the cut – Apple, Merck (NYSE: MRK ), Exxon Mobile (NYSE: XOM ), E.I. Du Pont (NYSE: DD ), Proctor & Gamble, 3M (NYSE: MMM ), Cisco, Pfizer (NYSE: PFE ), Boeing, Verizon (NYSE: VZ ) and Intel. Compared to the original cut, six of the eleven appear on both lists. Finally, only three of the eleven offer a potential return of 20% using analysts’ average one-year target – Apple, Pfizer, and Merck. Once again, Cisco misses the cut by less than 0.3%. Boeing also missed the cut by less than 1%. Yet, the original purpose in late August was to create a list containing 20%, or six, of the DJIA with the most potential based strictly on criteria and numbers. The six companies were then to be the focus of analysis for the coming months by my investment club. Similarly, after months of volatility, the purpose now is to determine how much the list has changed. Because the club already owns three of the top five, Apple, Cisco and Boeing, the next three in the sort will now make the cut. Therefore, the 20% left after the elimination criteria is applied include Pfizer, Merck, Verizon, DuPont, Exxon Mobil and 3M. The 50-day moving averages of the six are not more than 25% away from each 52-week high nor closer than 10%. The dividend yield on each stock is greater than the average for the DJIA. Combining the dividend yield and remaining growth to its one-year target, there is, at least, a 10% potential return. The following table depicts the pertinent data for the six companies not owned by my club as well as the three already owned. 50-Day Moving Average 52-Week High 50-Day MA from 52-Week High December 18th Closing Price One-Year Target Dividend Yield Potential Return Pfizer $32.98 $36.46 10.55% $31.99 $40.53 3.72% 30.42% Merck $53.73 $63.62 18.41% $51.64 $62.67 3.48% 24.84% Verizon $45.50 $50.86 11.78% $45.56 $50.27 4.96% 15.30% DuPont $66.90 $76.59 14.48% $63.40 $69.81 2.29% 12.40% Exxon Mobil $80.21 $95.18 18.66% $77.28 $83.71 3.68% 12.00% 3M $156.49 $170.50 8.95% $146.92 $159.71 2.77% 11.48% Apple $116.61 $134.54 15.38% $106.03 $149.05 1.88% 42.45% Cisco $27.40 $30.31 10.62% $26.27 $30.63 3.13% 19.73% Boeing $146.41 $158.83 8.48% $139.58 $162.83 2.55% 19.21% The next table depicts the buy points established for the list above. As in August, the buy points are established by requiring the potential of a 20% return. Also, as before, to be conservative, the lower of the one-year target or the 52-week high is used. Component Buy Point At or Below 52-Week High or One-Year Target Potential Growth Dividend Potential Total Return PFE $31.35 $36.46 16.30% 3.72% 20.02% MRK $53.78 $62.67 16.53% 3.48% 20.01% VZ $43.69 $50.27 15.06% 4.96% 20.02% DD $59.30 $69.81 17.72% 2.29% 20.01% XOM $71.96 $83.71 16.33% 3.68% 20.01% MMM $136.24 $159.71 17.23% 2.77% 20.00% AAPL $113.90 $134.54 18.12% 1.88% 20.00% CSCO $25.93 $30.31 16.89% 3.13% 20.02% BA $135.23 $158.83 17.45% 2.55% 20.00% Comparing the new list to the list derived in August reveals commonalities. Two of the six components repeat – Merck and 3M. Regarding the companies the club already owns, three of the four repeated – Apple, Cisco and Boeing. While the repetition may appear to reinforce an investment appeal, it is also possible it represents weakness or stagnation. The stocks that were bumped from the list did so because of performance. General Electric’s and Microsoft’s share prices increased over 20%. Coca-Cola and Johnson & Johnson both improved by 7%. Frankly, in the past, my investment club has not been interested in investing in pharmaceutical companies. Based on the potential return of the top two candidates, it may well be time to revisit that hesitancy. The DuPont/Dow Chemical (NYSE: DOW ) merger warrants a deeper dive by the club. Both Verizon and Exxon Mobil represent diversification opportunities to the club. Obviously, the cloud over the oil and gas industry can not be ignored though. Adding 3M to our portfolio would provide a personal triumph as it was my first suggestion when the club formed. And,yet, I’ve never pushed the suggestion. As well, it is equally reasonable to consider reinvestment in the three DJIA components we already own. The club will revisit direction, focus and goals for 2016 early in January. If embracing the DJIA and its volatility is a priority, the list is narrowed and possible buy points established. It would not surprise me to see additional index components in our portfolio by the end of next year.

How Prices Of ETF BIB Are Seen By Market-Makers

Summary This discussion, not a conventional review of biotech development pipeline conditions, is a study of how prices for the ETF are evaluated by market pros and the market’s subsequent reactions. Market-makers [MMs], regularly called on to negotiate volume (block trade) transactions in BIB have a special insight advantage – knowing trends of buy-side “order flow.” Why buy? or why sell? often is far less important to resulting price trends than “By how much, and how long it is likely to persist.” The MMs reveal their conclusions by the way they protect themselves and their at-risk capital commitments – in hedging. Behavioral analysis lets us know. How has the subject security been behaving? The ProShares Ultra Nasdaq Biotechnology ETF (NASDAQ: BIB ) is an issue with about 2 ½ years of markets transaction history, just under the three-year minimum we like to have for historical research and behavioral analysis. But it turns out to be an active enough subject to provide a good deal of perspective, in a dynamically competitive arena of intense and continuing interest to big-money investment organizations. Figure 1 shows how buy-side transaction orders have been prompting MM’s conclusions about likely coming price ranges day by day over the past 6 months. Figure 2 extends that same analysis to the past 2 years by means of extracting daily forecasts on a once a week basis. Figure 1 (used with permission) Price ranges indicated by vertical lines in these pictures are forward-looking forecasts of the likely extremes for BIB during the life of the derivatives contracts used to hedge MM capital put at risk in the process. The heavy dot in each vertical marks the closing price of the day of the forecast, and separates the range into upside and downside segments. The current day’s Range Index [RI] of 14 measures the percentage of the whole forecast range that is below that market trade. It defines the historic sample of 24 prior forecasts of similar upside-to-downside proportions used to evaluate the present-day forecast. The distribution of RIs available during the past 5 years (only 627 here) is shown in the lower thumb-nail picture. Quality of prior forecasts is indicated by only one of the 24 priors failing to recover from the -4.8% worst-case price drawdowns to earn a gain under the portfolio management discipline standard regularly used to compare alternative investment results. The other 23 (96% of the 24) combined with the loser to produce an average gain of +16.4% in an average holding period of 5 weeks (25 market days). That relatively short holding period contributed to the CAGR of +356%, the magnet of our wealth-building interest. Figure 2 (used with permission) Figure 2’s expanded time dimension provides a sense of its longer experience and how the values seen now relate to the past. Another comparative dimension is how BIB now relates to other investment alternatives. Figure 3 lists other Biotech-focused ETFs and provides perspectives on their size, market liquidity, and year-to-date price behaviors. Figure 3 (click to enlarge) Included in this table are the Market-proxy ETF, the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) and an inverse ETF, the ProShares UltraShort Nasdaq Biotechnology ETF (NASDAQ: BIS ) . BIS is structured to move in price 2x the opposite direction of its underlying index, while BIB holds mainly derivative instruments that leverage its price moves positively, to 2x the daily action of that same index. The index in question is the NASDAQ Biotech Index which is directly tracked by the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ). Its holdings are shown in Figure 4, strictly for perspective. Figure 4 An important aspect of any investment comparison is the trade-off between risk and reward. Figures 1 and 2 provide the data for BIB in side-by-side amounts of +13.3% and -2.9% in the rows of data contained in each. A visual comparison of those dimensions can be made from the map of Figure 5. Figure 5 (used with permission) The green % Upside Reward Scale at bottom of the map is quite understandable. But the red vertical scale of % Price downside may raise confusion between the downside portion of the forecasts and the worst-case price drawdowns of prior forecast experiences. Our experience is that the downside segment of the current-day forecasts is often exceeded by price drawdown experiences of prior like forecasts, and in turn, the current forecasts add to the priors. Besides it is not the forecasts that lead to capital losses (risk), but the experience of seeing investment prices descend below their entry cost prices, and staying there or getting worse, to the point where the investor throws in the towel and locks in a loss. When by having the fortitude to ride the stress out, he/she might likely see the position recover to a profit situation. So we use experiences rather than forecasts on the risk side of the equation. In Figure 5, BIB in position [3] clearly dominates most of the alternatives with a better trade-off. That adds to its quality advantage of a proven high-payoff history. BIS up in [6] is at the disadvantage of its “short” structure in a group where the current outlook is for higher stock prices. Conclusion: BIB currently presents a reasonably credible, albeit shorter, history of substantial rates of gain from earlier pro forecasts like that seen today. Investors should add to their own due diligence on the ETF’s competitive and profitability due diligence a hearty encouragement on the price-prospects front from market professionals.