BDC COMMON STOCKS

Week 48

Curious

This was a strange week in the markets.

The Dow Jones Industrial Average rose 0.8% to finish the week up 2.4% – and reached a new 52-week high. The S&P 500 advanced 0.8% this week. The Nasdaq also closed out the week 0.4% higher.

For what it’s worth, investor confidence reached a new complacency record. The ViX – also known by the over-dramatic as the Fear Index – fell to a level not seen since 2020.

Yet, the BDC sector price-wise had only an OK week.

Meh

The exchange-traded note with the ticker BDCZ that holds only BDC stocks fell (0.2%).

We also checked the S&P BDC Index on a price return basis and that dropped (0.3%).

Admittedly – and a little confusingly – most of the 42 BDCS we track were flat or up in price.

There were 25 in the black and 17 in the red.

No BDC fell as much as (3.0%), but 3 managed to increase by 3.0% or more.

One Idea

We’re guessing that all the speculation this week about the Fed cutting rates beginning in 2024 is beginning to erode BDC investor confidence.

We’ll save you the long list of different predictions about the speed and severity of the rate cuts investment banks are pushing out there.

Everybody has a different opinion about this critical unknowable factor at the center of the global economy – which also happens to be the main variable in BDC profitability.

Not So Simple

Silly things get said at times like this. Here’s an example from CNBC:

Interest rate cuts don’t happen during good times, something important for markets to remember amid hotly anticipated easing next year from the Federal Reserve.

This was written in the same week that a Fed governor suggested that – in fact – rate cuts would be appropriate in a growing economy as long as inflation was under control.

Boiled Down

Reading through the multitude of news reports on the subject it seems that there are two main camps – as there have been for two years now – those who believe a recession is around the corner and those who do not.

The former are predicting the Fed will cut rates substantially and soon, to prop up a soon-to-be struggling America.

The latter see cuts coming later in 2024, and of a more modest nature, stretching out the tapering over several years.

The Fed Chairman himself – to keep everyone on their toes – threatened to INCREASE rates if need be – something on nobody’s radar.

This is all to demonstrate that – notwithstanding encouraging inflation and GDP data this week and no material move in unemployment metrics – much uncertainty still lies ahead.

Even when the first Fed Funds rate decrease does occur, we’re unlikely to know what will follow.

Swings

To the BDC Reporter, this signals a “wall of worry” that BDC investors will either climb or they won’t – threatening to make 2024 a volatile time for sector prices as the market consensus about the future swings one way or another.

At the moment, though, BDC investors may believe we’ve reached peak earnings and distributions given that almost everyone but the Fed itself expects some sort of interest rate reduction in 2024 – possibly as early as March.

We’re not going to get drawn into these dangerous waters. Even the Fed Fund futures have been notoriously wrong on this subject – so much for the wisdom of the “clever money”.

We’re just warning our readers that how this mixture of economic growth, inflation, and the level of interest rates play out will greatly impact BDC results – and thus prices.

There is a very different earnings result for a BDC if the Fed Funds rate – and SOFR – hang close to where they are now versus dropping to 3.5% in short order.

Compounding the problem, if that 3.5% rate is due to a decelerating economy, BDCs could be facing both lower investment income and higher credit losses – after years where the former has grown like topsy and the latter has remained subdued and “manageable”.

Gilded Age

Yet there are “Goldilocks” scenarios where the BDC sector could prosper such as a slowly growing economy, amidst gradually dropping inflation and the Fed Funds rate dropping only marginally down to something like 4.5% over a couple of years.

Those sorts of conditions could maintain the BDC sector’s winning streak that began in 2022.

After all, BDC balance sheets remain strong; undistributed income levels are Treasure-Island high; liquidity is plentiful in most cases and there are relatively few new companies beginning to underperform.

However, there are many potential multiverses ahead, not all as promising as what we’ve described.

Where We Stand

We can tell you that at this stage, BDCZ has traded up 9.6% in price in 2023 YTD and the S&P BDC Total Return Index is up 23.1%.

16 BDCs are trading at or above the net book value per share.

29 BDCs are trading within 10% of their 52-week highs and only 3 within (20%) of the equivalent low.

Through December 1, 2023, 35 BDCs can boast a higher price in 2023 than at the end of 2022.

At this point, BDCZ is trading 20% above its two-year low set in the summer of 2022, and (10%) below the high achieved in the spring of last year.

There’s plenty of room for the BDC sector to move higher, but much of the heavy lifting has occurred – despite two mighty scares in the last 9 months.

Happy Holidays?

As we go into the final month of the year we wonder if BDC price momentum – which paused this week – will continue.

Or has the tide turned?