The market indexes have boomed since March. But a quick look under the hood tells a different story. Aside from technology, most of the market has struggled.
As of the end of May, the S&P 500 soared higher for nine consecutive weeks. The index closed May at a new closing high, up 20% from March 30th. But it was all technology. For the three-month period ending at the end of May, the information technology sector soared by over 30%. The next best-performing sector over that period was up 7% and the rest of the sectors averaged nothing.
The artificial intelligence trade came back into vogue after consolidating for more than four months. Those stocks soared despite the ongoing war in Iran. Most other stocks didn’t fare as well. For most of the rest of the market, the problem is oil.
Sure, there is uncertainty and headline risk from the war, which stocks don’t like. But the main problem is more tangible. The price per barrel of West Texas Intermediate (WTI) crude oil skyrocketed to over $100 from under $60 before the war. And prices have stayed elevated for more than three months. Oil is involved in everything. And that means inflation.
After being relatively subdued for most of the prior year, inflation spiked higher again in March and has also remained elevated. That means higher interest rates. The benchmark 10-year Treasury rate spiked well over 4% and to the highest level of the year. Higher inflation also makes the Fed less likely to cut the fed funds rate this year. In fact, investors are now expecting a rate hike before the end of the year.
The inflation and high interest rates are what kept most stocks down while technology soared anyway, even with the selloff last Friday. Despite a strong earnings quarter, most stocks meandered. But that’s in the past. The future is likely to be different.
The war is likely to end at some point before long and the Strait of Hormuz will open again. I know. Every week, there’s a potential peace deal that never happens. And even when the Strait opens, oil prices are likely to stay high for a while. But the situation is likely to be resolved before long, certainly well before the midterm elections. The current expectation of a Fed rate hike this year may be the high-water mark for interest rate pessimism.
Without the war, oil prices will fall. Interest rates will come down. That rate hike may be off the table. Even if it takes months after some sort of peace deal is reached, the writing will be on the wall. Inflation and interest rates will likely trend lower over the rest of the year. And stocks held back by inflation and high interest rates should be poised to move higher.
There are stocks that have been held down and are cheap because of a situation that is likely to reverse. The best time to get in is before these things happen and investors bid up the prices. Stocks that are cheap because of the war but are unlikely to remain so in the months ahead.
The pessimists have it all wrong. The resilient economy isn’t precarious. The current restraints are precarious. When the stronger economy unleashes, it will change things. Let’s get ahead of the curve with stocks that will benefit.
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Here’s a high-yielding, monthly dividend-paying stock positioned to benefit when oil prices inevitably come down.
Main Street Capital Corporation (MAIN)
Yield: 8.4%
Based in Houston, Texas, Main Street Capital is a Business Development Company that provides high-interest loans and takes equity stakes primarily in Lower Middle Market (LMM) companies. Main also makes debt investments in privately owned companies and larger Middle Market companies (MM).
The current portfolio consists of $9.2 billion of investment capital under management in 189 different companies across multiple industries throughout the United States. Investments are spread out between 89 LMM, 85 private loan investments, and 11 Middle Market companies. The average company investment size is $25.2 million. The portfolio is well diversified with no one company being more than 4.5% of the overall portfolio and most companies representing less than one percent.
While typically paying a high yield, the total return of most BDCs has been lousy over time. But MAIN is the exception. Prior to this year, MAIN had significantly outperformed the S&P 500 in the prior three-, five-, and ten-year periods. There are three primary reasons for the stellar performance.
Equity Stakes
Unlike most BDCs, which only make high-interest loans, Main also takes equity stakes in many of its portfolio companies. The appreciation of these companies’ overtime helps boost the portfolio value and thus the stock price over time. It also enables Main to use realized capital gains to pay supplemental dividends and boost the yield.
Lower Middle Market Companies
LMMs are smaller companies that are underserved not only by traditional lenders but also by other BDCs. The vast majority of BDCs focus on larger companies, leaving more opportunities with less competition in companies with $10 million to $150 million in annual revenue for managers with the savvy and expertise to identify the best, most-promising opportunities.
Internally Managed
Not only have the managers been among the best in the business but the in-house management means there are no external management fees and expenses. Operating expenses as a percentage of quarterly average total assets are currently 1.3% (0.9% excluding non-cash compensation expenses) compared to an average of 2.5% for banks and 2.5% for other BDCs.
But the price has been under pressure recently. MAIN is down over 30% from the 52-week high and has returned -4% over the past year (as of June 5th). The small companies in the portfolio are hit hard by the economic uncertainty caused by the Iran war, with high oil prices, inflation, and high interest rates.
The Dividend
One of the beautiful things about MAIN is that it pays a dividend every single month. It’s a great way to add to your cash flow. The regular dividend, last raised in January, is $0.26 per month or $3.12 per year, which translates to a 6.1% yield at the current price. But the BDC has been paying regular supplemental dividends consistently every quarter for several years. The current supplemental dividend per quarter has been $0.30 or $1.20 per year. Factoring in that extra dividend, the current yield is 8.4%.
As a Business Development Company, MAIN pays no income tax at the corporate level, which enables it to pay high dividends with money normally lost to taxes. The tax break is given to BDCs for the desirability of providing financing to small and growing companies that are underserved by traditional lenders. Although the dividend payout is higher than that of most traditional dividend-paying companies, the income is taxed at a higher rate.
History proves that MAIN has a formula that works. There is a high probability that stock returns will return to more normal levels in the months and years ahead. The current cheap price and high yield may enable an even better return than historical averages going forward.
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