Ride Out The Banking Mess With Reliable 7.3%+ Payouts

If there’s one thing we can be thankful for when it comes to the banking crisis, it’s this: at least it means fewer headlines about Fed rate hikes!

That’s actually a good thing for us, because, as the Fed statement hinted on Wednesday, the Fed is getting set to finally pivot. It’s the moment everyone has been waiting for all along! And it feels like almost no one is paying attention.

But we contrarian dividend investors are. And there are a couple of closed-end funds (CEFs) out there that are well-positioned to profit from the Fed’s quiet shift: the Nuveen S&P 500 Dynamic Overwrite Fund (SPXX) and the Nuveen Nasdaq 100 Dynamic Overwrite Fund (QQQX), which yield 7.8% and 7.3% respectively.

The nice thing about this duo is that besides tracking the major indexes (the S&P 500 and NASDAQ) they give us those high dividends by selling call options on their portfolios—a strategy that does particularly well when volatility spikes up.

And the underlying truth here is that, yes, it’s a bullish sign that the banking crisis has made the Fed less of an issue.

Last year’s bear market priced in all of the rate hikes we saw both last year and in 2023, so a few weeks back, when markets recently thought it likelier that the Fed would raise by 50 basis points at last Wednesday’s meeting, stocks didn’t move—everyone was too busy focusing on the failing regional specialty banks.

However, the Fed has also signaled it will pivot from higher rates in the future. The question is when. Now, futures markets are calling for the first rate cut to come in July, just two meetings from now.

Whether the cut comes then or later, getting the timing wrong by a few months is not a big deal in the grand scheme—which is why (beyond the fact that the regional-bank situation has knocked the Fed out of the headlines) the exact timing of the Fed’s pivot has also become a bit less important recently.

How to Play the Shift Toward Lower Rates

SPXX and QQQX are sound choices in this environment, the latter being an even more aggressive play on priced-in Fed rate hikes, due to its focus on the tech-heavy NASDAQ. Meantime, both funds offer us call-option income to profit from volatility.

Now let’s take a look at their recent performance, which gives us a big hint on each fund’s valuation. Despite having income streams five times that of their index-fund peers, these CEFs are both more or less tracking their indexes.

Note that this is total NAV return, meaning the profits that managers are earning by investing in the market. And you’d expect them to perform as they are, since these CEFs track the NASDAQ and S&P 500. But CEFs are different—which is why their market-price returns haven’t necessarily kept up.

QQQX’s market-price return is pretty close to its NAV, which translates into a 5.8% premium to NAV as of this writing. But SPXX is a different story…

SPXX is actually down on a market-return basis. This has brought SPXX’s premium to NAV, which was over 8% at the start of the year, down to a bit less than par. That’s a clear buying opportunity to play on later buy-in from CEF investors. Plus you get SPXX’s 7.8% income stream while you wait for that to happen.

Of the two, I’d lean toward QQQX now, however. The fact that its market price and NAV returns are similar for 2023 tells us that CEF investors are likely rotating assets out of the lower-risk SPXX and into the more aggressive QQQX.

This also suggests that investors think tech is more oversold than the broader market, and the broader market’s exposure to banks is a good reason to pivot. For that reason I expect more movement into QQQX over the medium term.

Michael Foster is the Lead Research Analyst for Contrarian Outlook. For more great income ideas, click here for our latest report “Indestructible Income: 5 Bargain Funds with Steady 10.2% Dividends.”

Disclosure: none