A coffee latte containing coffee grounds and cinnamon sticks.
Recent news articles have provided a clear picture of the current state of the US economy. I dub this phenomenon the “Cappuccino Effect.”
I must confess that it sounds excessively cute. But bear with me as I explain it, as I believe it highlights a timely purchasing opportunity in consumer-oriented equity closed-end funds (CEFs) with yields of 7 percent or more.
Let’s begin with inflation, which, as we are all aware, soared last year. Some people were unprepared for this, while others believed it would last a long time. Both turn out to be incorrect.
There are still a few news articles highlighting the fact that inflation is 3% instead of the Fed’s 2% target, but this argument is becoming more difficult to make given that the actual inflation rate is 2.97%, giving us a two-handle.
In addition, despite the human propensity for grumbling, an increasing number of people are observing that the prices of some goods are beginning to decline.
First, a surplus of milk in Wisconsin led producers to dump thousands of gallons of milk into sewers. Since February’s apex, milk prices have plummeted, and milk products are down 1.5%.
Milk Hits the Roof
Cynics will scoff at a minor decline in dairy prices, but it is significant: as a staple and food item, dairy is the type of product whose price either remains relatively stable or rises slowly.
If restaurants and retailers believe they cannot raise prices on cheese and cheese-containing products, this indicates that we do not live in an economy characterized by unchecked inflation.
Coffee is a tradable global commodity whose prices reflect a combination of demand and market conditions, and with coffee consumption constantly increasing and climate change causing bad weather (coffee plants are extremely sensitive to temperature and humidity), we should expect prices to continue to rise. Especially if the economy is inflationary.
However, they are not. Bloomberg reported earlier this month that a “fall in wholesale arabica bean prices [will] kick in after a lag,” explaining that wholesale coffee prices have likely decreased due to the resolution of supply-chain issues.
This will shortly result in lower coffee prices in coffee shops and supermarkets, even if we haven’t seen it yet. This is a report from the International Coffee Organization, not my opinion.
Coffee Prices Are Just Beginning to Fall.
Obviously, prices are still substantially higher than they were prior to 2020; the world has changed, and it is improbable that prices will decrease. However, they are unlikely to increase, which is significant for one reason: expenditure.
In July, the University of Michigan Consumer Sentiment Index increased to 72.6, exceeding expectations of 65.5 and marking the largest increase since 2005.
Clearly, this is still a historically low level; it is even lower than in 2009! But every indicator I’ve observed, including GDP, income growth, and productivity benefits, is better now than it was back then.
This is the beginning of the Cappuccino Effect: individuals are beginning to realize that they were unduly pessimistic and can, in fact, afford that cappuccino. Therefore, they spend a little more, and Starbucks Corp. (SBUX) earns a little more revenue. Furthermore, they spend more on purchasing items from their suppliers, who then spend more.
What relevance does this have to CEFs? Investing in the market now, while this cycle is still in its infancy, has proven to be a profitable strategy.
The 7%+ dividend yields of these funds make CEFs our preferred investment vehicle, as dividends account for the vast majority of our returns.
Several equity CEFs, such as the Liberty All-Star Growth Fund (ASG), are undergoing an additional intriguing development right now. The 7.8%-yielding fund has benefited from the recovery this year but is still trading below its net asset value (NAV, or the value of its underlying portfolios).
Holding retail (and retail-related) equities such as Microsoft (MSFT), Amazon.com (AMZN), and Visa (V), ASG is well-positioned to capitalize on rising consumer spending.
Currently, the fund yields 7.8% and trades at a discount of 3.3% to NAV. The fund has averaged a 1.2% premium over the past five years, so this premium is below the fund’s average over the past five years.
Even though the market price of the fund has increased by 22% since January 1, this indicates there is still room for improvement. Moreover, the fund’s NAV gains (up 18% this year) indicate sustained strong dividends (as the fund sells holdings at a profit and pays us cash).
ASG is one of the numerous equity CEFs that should profit as the sales, production, employment, and income cycles improve. This cycle is still in its early phases, and the majority of people are unaware that it is occurring.
But they will when they order a cappuccino and realize, “Wait, this isn’t as painful to pay for as it was a year ago.” This is how prosperous times begin.