I Left My Heart in DPO ~ The Risk Averse Alert

Tuesday, January 05, 2010

I Left My Heart in DPO

I came across an eye-opening post yesterday titled, "Carnage Continues: PHK (Who Smells Smoke?)." You can look at the write-up describing recent days' trading in this PIMCO high-yield debt fund and get your own sense of what is going on.

My interest here is to show you how fast things in the stock market might reverse. Truth is — and I have been raising this possibility — a trap door could open and lead to a rapid collapse. Take a look at recent action in the Dow 30 Enhanced Premium & Income Fund...

company chart (DPO)

Right back to July levels in a mere matter of days. THAT is the possibility we face.

Oh, and look how many issues of this leveraged fund were shoveled onto the market. Someone got a problem. It appears leverage, somewhere, has come undone and someone got a hankering for capital. It's the kind of thing that can spiral out of control very, very quickly.

(I know the difficulty remembering what you had for dinner last night, so recalling 2008's self-reinforcing, negative feedback loop might not be at the top of your mind. However, the risk of this breaking wide open is quite real. Treasury's Christmas present strongly suggests so.)

So, this is how the slow march of the past several months, ever so slightly higher sets up.

Now, I don't know if a collapse like DPO's is imminent. All I know is this is the risk — the path of least resistance. All things technical (and I mean ALL THINGS ... just to reiterate my reply to a comment in yesterday's post) support this view that every fundamental vulnerability, be they receiving media attention or (more likely) not, is building up to ... a heartbreak of historic proportion.

Fast Money
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Anonymous said...

Let me get this straight...

You're suprised that a fund trading at a 31% premium to NAV...which uses leverage...which just cut its dividend by 50%...which has been writing covered calls (thus capping its upside to this rally)...Fell back to...Its NAV? So you're saying investors don't like paying $1.31 for an asset worth $1?

Further...when volatility drops and options that this fund sells aren't generating the premiums they once did and therefore the prospects for income decline... that wouldn't affect the valuation of a security designed to provide "enhanced" income...?

How strange...

TC said...

No. I'm not surprised. Rather, that the facts you cite in all probability are not unique, and given the profound interconnectedness of all things wildcat finance (along with the apparent need to cut this thing's yield), there's reason to fear the kind of swoon we see here in DPO becoming more widespread ... indeed, even rapidly becoming a systemic phenom.

This view is no stranger than a former Goldman CEO turned Treasury Secretary falling on bended knee before the Speaker of the House, begging for $700 billion. This sort of thing, too, would not have been possible were everything not so profoundly geared and interconnected.

Anonymous said...

How can you extrapolate a chain of events from the goings on in a tiny (<$300mm) closed-end fund that lost $70mm in value after they cut their dividend?

It's not atypical to see a company that misses earnings & slashes their dividend to pay a hefty price when their shares open the next day. People expecting a 16% yield who will now be getting an 8% yield might be inclined to dump their shares...I fail to see the significance. A $300mm fund is a pittance in the global financial markets...no matter how interconnected markets may be.