2023-04-29 10:00:00 ET
Summary
- Shares of JEPQ have amassed over $2 billion in AUM as shares have produced over $5 from their previous 11 dividends.
- JEPQ utilizes ELNs to generate covered calls rather than writing covered calls on its assets and capping upside potential, making it a better fund for investors who want growth plus income.
- Based on the previous dividends, JEPQ would still generate over a 10% yield if shares appreciated to $50.
What's better than double-digit dividend yields? How about double-digit dividend yields plus capital appreciation? Since my first article on JPMorgan Equity Premium Income ETF (JEPQ) was published on 1/18/23, shares of JEPQ have increased by 6.51%, and when the dividends are factored in, the total return has been 9.82% compared to 3.3% on the S&P 500. Earnings season is in full swing, and big tech is pushing the market higher as Microsoft (MSFT), Alphabet (GOOG) (GOOGL), Meta Platforms (META), and Amazon (AMZN) have all delivered for investors. With Apple (AAPL) set to report on 5/4/23 , JEPQ could be well on its way back to the $50 level. JEPQ has gained a following and now has $2.28 billion in assets under management ((AUM)). I think JEPQ is an interesting play to generate a combination of capital appreciation and income in the future.
How JEPQ generates income without sacrificing all its prospects for capital appreciation
JEPQ operates in a similar fashion to its big brother, the JPMorgan Equity Premium Income ETF (JEPI). JEPQ invests in equities found within the Nasdaq 100 and creates an actively managed portfolio while selling call options through equity-linked notes to generate income. JEPQ has an 80/20 split where it invests at least 80% of its assets in equities securities, and the other 20% is allocated to ELNs. This allows JEPQ to generate significant income relative to what traditional dividend-focused ETFs generate while not crippling the upside potential by writing covered-calls on the equities within its portfolio. This is the main aspect that separates JEPQ from the Global X Nasdaq 100 Covered Call ETF (QYLD) as they both invest in equities found in the Nasdaq 100, but QYLD writes covered calls against the portfolio, while JEPQ confines its options overlay strategy within the ELN portion of the overall portfolio.
ELNs aren't common, so I am going to quote my previous article to break down what they are and how JEPQ utilizes them for income:
ELNs are structured as notes that are designed to offer a return linked to the underlying instruments within the ELN. The ELNs that JEPQ invests in are derivative instruments that combine the economic characteristics of the Nasdaq 100 and written call options in a single note form and are not traded on an exchange. The options within the ELN will be correlated to the Nasdaq 100 or an exchange-traded fund that replicates the Nasdaq 100, such as the Invesco QQQ ETF ( QQQ). JEPQ looks for ELNs that are structured to use a covered call strategy and have short-call positions embedded within them. When JEPQ purchases an ELN, JEPQ is entitled to the premiums associated with the options which provide recurring cash flow. The ELNs are reset periodically to seek to better opportunities based on market conditions.
JEPQ is still less than a year old, and it's delivering consistent monthly income that amounts to double-digit yields
Over the past year, the Nasdaq has declined by -2.78% while the Invesco QQQ Trust ETF (QQQ) has appreciated by 1.01%. It's been a rough investing environment as some investors faced their first real bear market, and many growth companies that couldn't lose in 2021 saw their stocks crater in 2022. While the Nasdaq reached a high of 13,181.09 and a low of 10,088.33 over the past year, JEPQ has been delivering income each month regardless of market dynamics, the macroenvironment, the Fed, or any other obstacle the Nasdaq has faced.
JEPQ has paid 11 dividends since its inception at the beginning of May 2022. In total, shares of JEPI have produced $5.18 in dividend income from its first 11 dividends. Assuming that JEPI stays in line with the previous 3 months, it should generate roughly $0.44 for its 12th dividend, as this is the previous 3-month average for its dividend income. If this occurs, JEPQ will generate $5.62 in dividend income from its first year of dividends. Assuming shares return to $50 by the time this occurs, JEPQ would have a trailing twelve-month ((TTM)) yield of 11.24%. As it stands now, JEPQ has generated $5.18 in dividend income which is a TTM yield of 11.38%, and the 12th dividend hasn't occurred yet.
The smallest monthly dividend JEPQ has produced was $0.34, and there have been 3 dividends under $0.40. JEPQ's largest monthly dividend was $0.68, which was the only monthly dividend that exceeded $0.60, while the rest of its dividends fell between $0.41 and $0.58. The average monthly dividend that JEPQ has produced is $0.47, and if this is the standard average dividend going forward, JEPQ will deliver $5.65 in dividend income over the next year. This would place JEPQ's forward dividend yield on its current share price of $45.50 at 12.42%.
JEPQ could mount a rebound and still deliver a 9% plus yield
The QQQ has rebounded 19.33% YTD, yet it's still only up 1.13% over the previous year, and 1.01% in the past 5 days. We're still a ways off the highs as QQQ would need to appreciate by 24.97% to reach its previous high of $400.35 made on 12/30/21. Hypothetically, if QQQ was to jump 24.97% and JEPQ followed, JEPQ would add $11.36, placing its shares at $56.86. If JEPQ the average monthly dividend of $0.47 was used as the standard to determine the forward dividend payout, JEPQ would have a $5.65 dividend placing the forward yield at 9.94% based on a $56.86 share price ($5.65047 / $56.86258).
So how likely is it that QQQ will rebound, and JEPQ will follow? That's the real question. Let's go back and look at the history of the broad market. The reason I want to do this is because the data set is much larger. While the S&P 500 has had 26 years in the red since 1928 (28.57%), it's very uncommon for back-to-back negative years to occur. Since 1928, the S&P 500 declining YoY sequentially has only occurred 8 times (8.79%). Over a 40-year period from 1981 - 2021, each red year or string of red years was met with a minimum of 3 consecutive years in the positive. Coming off of a -4.7% return in 1981, the market had 8 years of appreciation; after a down year in 1990, there were 9 consecutive years of appreciation; after the string of down years from 2000 - 2002, the market appreciated for 5 consecutive years, after the crash in 2008 the market went on a 9-year bull run, and after a down year in 2018, the market had 3 double-digit years of growth.
This is applicable to the Nasdaq because the largest companies in the QQQ are Microsoft, Apple, Amazon, NVIDIA (NVDA), Alphabet class A and C, Meta Platforms, Tesla (TSLA), Broadcom (AVGO), and PepsiCo (PEP). These companies represent 55.09% of the QQQ. The largest companies in the SPDR S&P 500 ETF Trust ( SPY ) are AAPL, MSFT, AMZN, NVDA, GOOGL, Berkshire Hathaway (BRK.A) (BRK.B), Alphabet class A and C, Exxon Mobil (XOM), Meta Platforms (META), and UnitedHealth Group ( UNH ) which represent 26.9% of the fund. These funds cross over on 7/10 of the top ten companies. Over the past decade, big tech has led the markets higher as AAPL, MSFT, AMZN, GOOGL, and META have appreciated between 436.48% and 1,030.26%.
When I look at the earnings estimates going forward through 2025 for big tech, they are expected to increase EPS by the following amounts:
- AAPL $5.97 in 2023 to $7.14 in 2025, 19.6% increase
- MSFT $9.64 in 2023 to $12.54 in 2025, 30.08% increase
- AMZN $1.43 in 2023 to $3.55 in 2025, 148.25% increase
- GOOGL $5.28 in 2023 to $7.34 in 2025, 39.02% increase
- META $9.78 in 2023 to $14.70 in 2025, 50.31% increase
In addition to big tech growing earnings, the crash of 2022 has pushed efficiency and profitability front and center. Unprofitable tech companies have been forced to redefine their operations from growth at all costs to capital efficiency and generating profitability. The combination of the old guard getting more profitable and younger companies throughout the Nasdaq becoming more efficient and profitable could help fuel the next leg up in the market.
The other aspect is the macroenvironment. We're at the end of the tightening cycle, and the Fed is going to stop raising rates at some point in 2023. We haven't seen the impact of a Fed pause or the start of a reduction in rates. Inflation peaked in June of 2022, and since then, we have seen 9 consecutive quarters of declines as inflation has fallen from 9.1% to 5%. It's entirely possible that we will see inflation under 3% this summer and get close to 2% this fall which could force the Fed to start cuts sooner than anticipated. If inflation falls enough to the point where the Fed pivots in 2023, it would be a bullish signal that could push the market higher well into 2024.
If you're a long-term investor and not a trader, the markets should ultimately appreciate just as they have going back to 1928. I don't have a crystal ball, but I interpret the data in a way that makes me believe a bull market could start in 2023 or 2024. If my logic is correct and that occurs, the JEPQ should benefit as the companies that took us to market highs should push the market higher in the next leg up.
Conclusion
If you're looking for income, or you're looking for income with prospects for capital appreciation, JEPQ should be on your list. JEPQ takes a different approach to covered-call ETFs as it exposes 20% of the portfolio to ELN's to generate additional income through its options strategy. I think we're closer to a bull market than a bear market, and the economic and earnings data looks as if 2023 and 2024 could be capital appreciation years. The QQQ has a larger concentration in big tech, and big tech is likely to lead the market higher. I think JEPQ will generate a double-digit yield for a while, and if the market gets back to its previous highs, JEPQ could still generate a 9% plus yield based on its average monthly dividend. I am long JEPQ and with the way this earnings season is looking, I won't be surprised if JEPQ goes higher with the market.
For further details see:
JEPQ Probably Headed Higher And Still Generating A 10% Plus Yield