How Economic Data Misses Can Benefit High-Income Investors

Last Thursday, the S&P 500 established a new all-time closing high of 2,121 as a result of yet another soft piece of data, this time the Producer Price Index for April, which came in at -0.4% versus economists’ forecast of 0.2%. Treasuries rallied off the headline, European stocks reversed higher from trading in the red and U.S. equities were off to the races. Once again, bad news is good news, as the fear of Fed tightening is pushed out further in the eyes of investors.

The rally in bonds continued into Friday, the yield on the benchmark 10-year Treasury falling to 2.17% following the release of four more weaker-than-expected economic data points. The Empire Manufacturing report of 3.1 was below the 4.5 consensus, Industrial Production for April came in at -0.3% versus expectations of 0.1%, Capacity Utilization for April was 78.2% versus 78.4% consensus and the all-important read on Consumer Sentiment came in at 88.6, well short of the consensus forecast of 96.0.

At some point, the notion of the Fed sitting out any form of a rate hike until 2016 will start to be priced into the market if the data continues to disappoint. Assuming this is the case, perception will transform into reality: sideline money will commit to dividend-paying equities and other income-generating asset classes under the influence of the notion that the threat of fighting the Fed has been greatly diminished.

My vocally public view has been and remains squarely in the camp that the Fed will stay put and continue to voice their position of being data dependent, holding out for better numbers in the current second quarter to look for improving trends. When an economy that runs on consumer spending is not delivering upbeat data with the tailwinds of incredibly low interest rates and gas prices that are 50% lower than a year ago, something else is in the mix that doesn’t jive with these two powerful catalysts that should be propelling the consumer to spend.

Last week’s bump in interest rates is starting to look more like a fake-out instead of an upside break-out. In light of these most recent developments, the landscape for high-yield investing just gets better and better. What is most encouraging is the avenue by which income investors can target those pockets of economic strength like technology and life sciences, both of which as sectors are outperforming and are coveted by growth investors and fund managers alike.

To capture a piece of that action and garner an outsized yield, investors should consider taking a position in Horizon Technology Finance (HRZN), a business development company (BDC) that conducts what is called “venture lending” to small to medium-sized private companies in the life sciences and high-tech space. The loans they make are senior secured and come along after companies have been funded by venture capital firms that provide initial start-up capital.

A venture loan not only pays well, typically 10-18%, but also contains equity warrants attached to the loan, allowing Horizon to participate in a future exit strategy, either an outright sale of the company or an initial public offering (IPO). Shares of HRZN pay a current annual yield of 9.8% with management having gone the extra mile for investors by having in place a monthly payout for dividends. As a result, the price action of the stock is stable. Of the 50 companies within Horizon’s loan portfolio, 74% are of the floating rate variety, with an annualized portfolio yield of 15.0%, meaning there is ample income to cover the 9.8% dividend yield and fund operations. The current payout ratio for shares of HRZN is 86.0, an enviable number in the high-yield space.

The market capitalization for Horizon is $164 million, a virtual microcap by definition compared to the plethora of well known BDCs with billion-dollar market caps. But this is what makes Cash Machine a very special income advisory service. The company is covered by only five analysts, with Oppenheimer being the most recent to initiate coverage on May 13, 2015, with an Outperform rating, following an upgrade by Wunderlich on March 12, 2015, to a Buy rating. So the Horizon story is being viewed very favorably by the analyst community in addition to myself. We added HRZN to the Cash Machine model portfolio on April 17, 2015 at $14 and suggest income investors take the same action.

In case you missed it, I encourage you to read my e-letter column from last week about why investors shouldn’t try to fight the four feds. I also invite you to comment in the space provided below my commentary.