If You’re Buying Stocks, You’re Making a Big Mistake

If you are buying stocks, you are a making a big mistake.

That’s what Andrew Mickey wrote Friday, August 12th, 2011 in the Wealth Daily. He said he acknowledged that all the contrarian indicators are flashing green: Stocks are way down. Insiders are buying. The Fed declared to keep interest rates at 0% into 2013.

The little trust that investors regained in the market over the last two years has been completely shattered.

A survey released this week by MFS found investors are sitting on 26% cash, and they’re building more cash reserves by selling into the recent volatility.

Even Donald Trump, who rarely buys stocks, said he bought Bank of America (NYSE: BAC) and Citigroup (NYSE: C) this week. And Christian DeHaemer, my colleague who has successfully profited through every type of market you can imagine, has astutely pointed out “this is not 2008.”

I’m not saying stocks are a buy here or not. Frankly, there’s no way to tell where markets are going to head in the short term.

There is, however, a much better bet than stocks right now.

This often overlooked corner of the market is currently safer than stocks. It offers significantly more upside than stocks. And when it has fallen to current levels in the past, investors were handsomely rewarded.

Better than Stocks: Less Risk and More Upside

One of the most little-watched corners of the markets is Closed-End Funds (CEF) — and for good reason.

CEFs are funds that trade like normal stocks. They usually contain a broad basket of stocks or bonds and move up and down with the overall markets. They are controlled by the same inept fund managers who consistently fail to even match the market, let alone beat it, and consistently lag the overall markets by a wide margin.

In short, CEFs are normally terrible buys.

The past week, however, has been anything but normal. And it’s created one of the rare times when CEFs outperform stocks in general.

You see, since CEFs aren’t marked to market at the end of each trading day, they trade at the price the market will bear. As a result, their Net Asset Values (NAV) can vary widely from their trading prices on the open market.

When CEFs trade below their NAV, they are discounted; when they trade above their NAV, they’re at a premium.

During periods of extreme pessimism, you can buy them at significant discounts to their NAV. In essence, you can get into a broad basket of stocks or bonds at 10% to 15% less than market value. It’s the equivalent of buying stocks for 85 or 90 cents on the dollar.

One of those rare times of intense pessimism is right now.

Most CEFs are trading at significant discounts. The significant discounts are a great signal for investors looking to get in cheap and for the markets in general.

Here’s why…

The Best “Buy Indicator” You’ve Never Heard Of

On average, between 50% and 65% of all the 600 or so CEFs trade at a discount to their NAV. Remember, they’re normally terrible performers. The market knows that. And it discounts the majority of them for it.

The discounts will usually range from as much as 10% to as little as 1% for some of the top-performing CEFs. And during times like now, those discounts will double — or more. Right now, most CEFs are trading at a greater than normal discount to NAV. More importantly, a far greater number of them trade at discounts than they do normally.

Consider this: The CEF discount-to-premium ratio, which compares the number of discounted CEFs relative to those trading at a premium, has fallen to levels last seen at the peak of the market meltdown in 2008.

Nearly all CEFs were trading at a discount at the market bottom in late 2008 and early 2009. At the peak of pessimism, 91% of CEFS were discounted — far higher than the normal range of between 50% and 65%.

After the past week’s wild swings, the percentage of CEFs trading at discounts to NAV has surged to more than 85%.

According to CEFs, this downturn is almost as bad as 2008. For a number of reasons though, this is not 2008.

And if you’re looking to jump on a potentially quick rebound in stocks, CEFs at these levels are the best way to do it.

 

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