BDC COMMON STOCKS

Week 1

Wah-Wah

If you’ve been listening/watching CNBC this week and/or reading the financial press, you’ve heard a lot of moaning and groaning about the weak start to the new year of the major indices.

The NASDAQ was down (3.2%) in just 4 days, its biggest percentage drop since September of last year. The S&P 500 fell (1.5%) and the Dow Jones (0.6%).

(We’ll allow ourselves to step up on our soapbox briefly to wonder whether investors and pundits have become a little entitled after weeks and weeks of an everything rally. It’s not a market if prices only go up).

Divergent

Anyway, the BDC sector – as happens once in a while – went off in a completely different direction – increasing by 2.2% in price.

That was the percentage price increase for BDCZ – the thinly-traded but useful exchange-traded note that owns virtually all the BDC stocks.

BDCZ closed at $19.38, slightly below the ETN’s 52-week high of $20.00.

That other measuring stick we use – the S&P BDC Index calculated on a “total return” basis – was up 2.26% – very, very close to its all-time high.

Major Metrics

All the data points we track weekly reflect the continuing rally in the BDC sector.

Here are some highlights:

34 individual BDCs saw their stock price increase in this first week, with only 8 in the red.

Of the BDCs in the black, a robust 10 were up 3.0% or more as investors went shopping.

No BDC fell more than (2.5%) in price.

Once again, several BDCs reached new 52-week price highs.

The tickers involved are ARCC, CSWC, FSK, and HRZN – reflecting an interesting mix of underlying BDC strategies.

Tip Top

Just as reflective of BDC investors’ animal spirits is that only 1 BDC is trading within 10%) of its 52-week low and 30 are within 10% of their highs, including 19 within 5%.

Going by that last statistic, that’s as good as it’s gotten since late 2021.

Furthermore, 18 BDCs are now trading at or above their net book value per share.

That high a number has not occurred since August 2022.

We’re undeniably in “hot,hot,hot” territory.

Reason Why

We have a pet theory as to why this is happening this week – and in such sharp contrast to most other securities.

The sudden doubts in the zeitgeist about how quickly and how much the Fed might cut interest rates was “bad news” for most stock market players but not those involved in the BDC sector.

Interest rates higher for longer – or even subject to an increase as the Fed hinted might still be possible – means higher profits and distributions for BDCs.

Our crystal ball has been saying for some time that rates seem unlikely to budge before mid-year and even then will only get reduced slowly.

As a result, the BDC sector might get to peak earnings and distributions in 2024, outperforming the record already achieved in 2023.

If so, that would mean this still under-appreciated corner of the markets will be able to boast of 3 fat years in a row, courtesy of the Fed’s war on inflation.

Moreover – as all our readers must know by now even if they only occasionally dip into these pages – BDC balance sheets are strong; credit challenges are “normal” and manager confidence is high.

According to Seeking Alpha data 41 of 42 BDCs have generated a positive total return over the past 3 years, including 7 BDCs that can point to 100% plus gains over this time frame.

What’s not to love? BDC investors seem to be saying and with good cause.

Outlook

At this point, BDCZ has to increase only 6.2% to match its highest level of the past two years.

The same holds even if we use a 5-year time frame.

Daunting

On the other hand, BDCZ is 25% and 100 % above its two-year and five-year closing lows.

If you have a fear of heights, don’t look down.

Being Paid

However, BDCZ is paying out a quarterly distribution – going by the IIIQ 2023 payout – 17% higher than in 2020 and 2021 and 7% higher than in 2019.

One could make an argument – and we have in other venues – that BDCZ’s 2024 price could end up far outshining the peaks of the last 5 years.

Rough With The Smooth

One big question mark is whether investors will ante up in the full knowledge that odds are high that by the summer or fall rates will start to drop and that the next few years are likely to see a descent in the base SOFR rate on which virtually all loans are set of (50%) or more.

That’s not happening yet as we’ve seen but these things can turn on a dime or a government CPI report.

Not So Soft Landing

The second big question is whether all the naysayers about the outlook for the U.S. economy – once the dominant voice in American business but now a diminished, but stalwart minority – prove to be right at some point in 2024.

The R-word tends to send investors into a tailspin, especially those in leveraged lending.

We refer you back to March 2020 for an extreme example, when BDCZ fell more than (50%) in 6 weeks. Or there’s the (25%) drop in the spring and summer of 2022 even though the Godot recession ultimately never arrived.

Reporter. Not Prognosticator

The BDC Reporter is not here to make projections about where BDC prices are headed.

We do that in BDC Best Ideas and we’ll be tackling this thorny subject for our subscribers in our sister publication this week.

Best Of Times/Worst Of Times

All we’ll say here is that we’re in a very dangerous period for anyone either long BDC stocks or with money burning a hole in their pocket.

There’s a rational FOMO at a time when virtually every BDC is a winning bet and the Fed seems to be extending the runway further.

At the same time, what goes up does tend to come down where BDC prices are concerned. Our chart gazing shows that the sector since 2023 has witnessed at least ten “corrections”.

No Time To Relax

Our unsolicited advice to anyone who is not committed to sticking with their BDC investments through thick and thin is to keep your eyes wide open.

BDC common stock investors rarely get to sleep well for long and the nightmares – when they come – can be pretty vivid.