2023-10-09 08:45:00 ET
Summary
- JPMorgan Nasdaq Equity Premium Income ETF has declined by -2.9% compared to the S&P 500, but has increased by 15.88% YTD.
- JEPQ provides a blended approach for income investors, generating double-digit yields and potential capital appreciation.
- The Fed's stance of higher rates for longer makes JEPQ more attractive, especially in comparison to traditional income investments.
Since my last article ( can be read here ), the JPMorgan Nasdaq Equity Premium Income ETF ( JEPQ ) has declined by -2.9% compared to the S&P 500, falling -4.47%. When JEPQ's distributions are accounted for, its total return since 9/5/23 has been -2.03%. Despite the recent market fluctuations, JEPQ has increased by 15.88% YTD and generated $3.77 in income, which is a 9.27% yield since its 2023 starting price. JEPQ will pay 2 additional distributions this year, and shares are positioned well if the Fed holds rates higher for longer. I am changing my opinion on JEPQ from bullish to very bullish going into 2024 and plan on adding to my position going into the end of the year. If you're an income investor, JEPQ provides a blended approach that should continue to generate double-digit yields and capital appreciation if the markets rise into 2024.
A lot has changed since my last article and I want to provide an update as to why I am now very bullish on JEPQ
In my article, which was published on 9/5/23, I discussed the macroeconomic environment and its relationship to JEPQ and how JEPQ was performing compared to covered call ETFs. Prior to the latest Fed meeting, we saw Core CPI continue downward from 4.8% in June to 4.7% in July. CPI ticked higher from 3% to 3.2% in the July numbers, and the Fed was still giving hope to investors. The St. Louis Fed had projected that rates would fall to 4.6% in 2024 and 3.4% in 2025, and JEPQ was significantly outperforming the Global X Nasdaq 100 Covered-Call ETF (QYLD).
A lot has changed in the past month as the Nasdaq has fallen -3.89% despite being up 29.31% YTD. In the latest CPI report, inflation rose from 3.2% in July to 3.7% in August, but Core CPI continued to fall from 4.7% to 4.3%. There are less than 25 days until the next FOMC meeting, and the CME Group Fed Watch Tool is showing an 11.2% chance of a .25 bps increase for November and a 39.5% chance we see a .25 bps increase in December. The St. Louis Fed has projected that rates will be higher for longer as they see rates falling to 5.1% in 2024 rather than 4.6% and 3.9% in 2025 rather than 3.4% from the last projection.
The economic sentiment changed after Jerome Powell delivered an extremely hawkish speech after the FOMC meeting. There were no mincing words as he was clear that rates would be higher for longer and a rate cut would not occur in 2023. He also left the door open for future increases if the Fed deemed necessary. On 10/6, the United States non-farm payroll data came it hot as 336,000 jobs were added. This was a significantly larger beat than the market prediction of 170,000 and the upward revised number in August of 227,000. On Thursday, 10/12 we're getting CPI and Core CPI data for September, and if inflation is hot, we could see the CME Fed Watch Tool probability for a hike in November spike.
Why I am upgrading my stance on JEPQ as an income investment
I was previously bullish on JEPQ, but after the new economic data becoming available, I am upgrading my position to very bullish. We are living in a rising rate environment, which has not only made treasuries extremely attractive for income but also crushed the value of many dividend stocks. Traditional income investments such as REITs and utilities have been decimated in 2023. The Vanguard Real Estate Index Fund ETF Shares (VNQ) has declined by -9.98% YTD, while the Utilities Select Sector SPDR Fund ETF ( XLU ) has dropped by -18.79% YTD. The yield on the 12-month treasury note is yielding 5.44%, while you can lock capital up in a 2-year note at 5.08%. Taking a long-term approach, the 10-year yield is 4.79%, and the 30-year yield is up to 4.96%. From an income perspective, the risk-free rate of return is nothing to look over at this point, and treasuries are a real alternative to taking on equity risk.
I can't predict what the Fed will do, but from the beginning, I have said that I didn't think rates were going to be cut in 2023. The Fed was late to the party in increasing rates, and the last thing any Fed member wants is to be wrong again. Conventional wisdom would cite that we're headed into an election year, and there will be political pressure to reduce rates. People will also argue that there is a credit crunch looming, and rates need to decline due to the amount of debt in the real estate market that needs to be refinanced. There will also be a discussion about the stalled housing market. All of these are valid points, but I see the Fed sticking to inflation and maximum employment above everything else. The fact that the economy is hot and unemployment is not increasing after the quickest rate hikes since the early 1980s insinuates that the economy can endure higher rates for longer. If the Fed doesn't change course and sticks with its current narrative, we could see income investments have another tough year in 2024, which would make JEPQ more attractive.
At the beginning of 2023, the 2-year note yielded 4.41%, and people were plowing cash into notes prior to the AI tech boom in the spring. Putting capital to work in JEPQ generated a 15.88% return, but for income investors, it provided monthly income as well. JEPQ has paid 10 distributions in 2023, amounting to $3.77 of income. This is an effective yield of 9.27% on invested capital, as JEPQ traded for $40.67 at the beginning of 2023. If I add the two distributions from November and December of 2022, it brings the amount of income JEPQ has generated in the TTM to $4.89. If the next 2 distributions replicate the ones from 2022, then JEPQ will pay $0.45 per share in November and $0.42 per share in December. If this occurs, then investors who added JEPQ at the beginning of 2023 would see a 12.02% yield on invested capital, and if shares of JEPQ stay the same price as they are now, the TTM yield would be 10.38%. JEPQ's TTM yield on either invested capital or the current share price is almost double every risk-free asset yield. Income investors are not incentivized to invest in Pepsi-Co at a 3% yield when the risk-free rate of return exceeds 5%, but generating a double-digit yield is a much more compelling case to take on equity risk.
It's not a secret that many stocks are having a bad year, and big tech is keeping the market higher. The Coca-Cola Company ( KO ) has declined by -15.58%, while Verizon ( VZ ) is lower by -15.91%. Utilities, which used to be proxies for bonds, have gotten crushed due to rates as Southern Company ( SO ) declined -10.17% and NextEra Energy ( NEE ) fell -36.33% YTD. I look at what's happened and not knowing what the Fed will actually do, I want to be in large caps that have pricing power and earnings expansion. If rates stay higher for longer, I believe large-cap will continue to suck up capital as they have tremendous balance sheets, pricing power, and earnings growth on the horizon.
JEPQ is heavily weighted toward tech with 49% of its assets allocated to the sector. We also see Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN), Nvidia (NVDA), and Meta Platforms ( META ) in the top-10 holdings. Look at the cash-to-debt ratios for each of these companies:
- Apple
- Cash on hand $62.48 billion
- Long-term investments $104.06 billion
- Total debt $109.28 billion
- Liquidity to debt ratio of 152.40%
- Microsoft
- Cash on hand $111.26 billion
- Long-term investments $9.88 billion
- Total debt $79.44 billion
- Liquidity to debt ratio of 152.48%
- Alphabet
- Cash on hand $118.33 billion
- Long-term investments $31.22 billion
- Total debt $29.43 billion
- Liquidity to debt ratio of 508.14%
- Amazon
- Cash on hand $63.97 billion
- Long-term investments $2.53 billion
- Total debt $174.29 billion
- Liquidity to debt ratio of 38.16%
- Nvidia
- Cash on hand $16.02 billion
- Long-term investments $.8 billion
- Total debt $10.95 billion
- Liquidity to debt ratio of 153.61%
- Meta Platforms
- Cash on hand $53.45 billion
- Long-term investments $6.21 billion
- Total debt $36.98 billion
- Liquidity to debt ratio of 161.32%
Of these 6 companies, only AMZN has more debt than liquidity on their balance sheet. In total, these 6 companies have $580.21 billion in liquidity and $440.37 billion in total debt, putting their combined liquidity-to-debt ratio at 131.18%. There are many reasons why big tech has been in the spotlight in 2023, and one of those reasons is that rates are not impacting them. Amazon is the only one that doesn't have enough liquidity to eliminate their debt, which is a rare thing to find. When I look at the income statements, the other crazy statistic is that 5 of the 6 companies have generated more EBITDA in the TTM than the total debt on their balance sheets. These are the types of companies that will flourish in a higher for longer environment because with the exception of AMZN, they have the ability to facilitate or eliminate their debt, and their incoming EBITDA exceeds their debt. These companies are not being impacted by rates because they are barely leveraged and are seeing earnings expand.
Steven Fiorillo, Seeking Alpha
These 6 companies are expected to see YoY earnings growth from 2023 through 2025. The collective range is 17.11% to 97.72% in EPS growth, with the average being 52.31% over the next 2 years. One could make an argument that the group looks cheap on forward 2025 earnings with an average P/E of 22.32. I am invested in 4 of the 6 as earnings power is going to play a more important role than ever, and JEPQ's focus on these companies and tech, in general, makes it very interesting for a rate environment that is higher for longer. JEPQ's exposure is skewed toward companies that have strong balance sheets and expanding earnings, which helps negate the impacts of rising rates.
Conclusion
I am more bullish than I was on JEPQ due to the Feds stance of higher for longer. JEPQ is constructed to blend capital appreciation and income by running its options overlay strategy on the 20% of its portfolio segmented for ELNs. JEPQ is one of my top ideas for 2024 for investors looking to benefit if the markets go higher while generating yields that more than double many of the current risk-free rates. If we're in an environment where rates are higher for longer, there are several sectors that could continue to suffer, such as utilities and REITs. I think big tech will do well as they are unleveled and have strong earnings growth ahead of them. JEPQ can perform well in the current environment and outperform if the Fed pivots in 2024. Investors don't have to sacrifice growth for income with JEPQ, and generating double-digit yields with the prospects of modest appreciation is where I want to be.
For further details see:
JEPQ Looks Enticing After The Pullback And Double Digit Yield