China’s Monetary Waves and the Contrarian Dilemma

As income investors, we often overlook international stocks, which is a missed opportunity. Incorporating these assets into our portfolios can not only enhance our income streams but also add a layer of safety to our investments.

One effective strategy involves utilizing high-yield closed-end funds (CEFs) to “time” investments between U.S. and international stocks, potentially achieving an attractive 9.2% yield that can be built up over time by periodically rebalancing our portfolio.

The catalyst for this strategy lies in developments in China, an emerging market that could pave the way for more substantial overseas income opportunities.

Could Chinese Stocks See Annual Gains of 13%?

Amid discussions about tariffs, a significant announcement has been made with China unveiling a new stimulus package. While specifics are yet to emerge, this news has positively impacted Chinese stock prices.

The details of the package are still unclear, but it may mirror the quantitative easing initiatives implemented in the U.S. during the 2010s following the subprime mortgage crisis and again in 2020 due to the pandemic.

Historically, these stimulus measures paid off for U.S. investors, with the S&P 500 experiencing a 13.0% annualized return in the five years following the first round of stimulus and an astounding 84% in the two years after the pandemic-triggered measures. However, the latter gain resulted from an unprecedented market crash followed by a rapid recovery, so it’s essential to focus on the more stable returns.

This brings us to the prospect of whether Chinese stocks could also enjoy a sustainable 13% annualized growth over the next five years. It’s important to note that since their peak in 2021, Chinese stocks have plummeted nearly 50%, presenting a seemingly attractive entry point for contrarian investors.

Recent trends indicate some signs of recovery as China recognizes the necessity of bolstering its economy, illuminating another opportune moment for investment.

For those of us interested in closed-end funds, a great way to engage with this market could be through the China Fund (CHN). Currently, it offers a compelling 16.3% discount to its net asset value (NAV), making the underlying Chinese assets even more appealing.

Opportunities in Chinese Assets at a Growing Discount

Despite the optimistic shift in Chinese stocks, CHN has unfortunately been experiencing a decline, making it seem like a prime opportunity for value investors. However, history shows us that such situations can be misleading. Past attempts by China to stimulate its economy have often fallen short.

For instance, in 2016, following a major stock market crash, the Chinese government initiated measures to support its financial assets, resulting in a notable 21.7% return the subsequent year. Nevertheless, since then, the Chinese market has achieved a mere 3.5% annualized return, as stimulus efforts struggled against the backdrop of a tightly controlled and closed economy.

While CHN managed to outpace the index, its managers delivered only a 5% annualized return over the same period, which hardly compares to more stable high-yield savings accounts in the U.S.

A More Balanced International Approach

With the recent performance of U.S. stocks, diversifying into international markets becomes a prudent move. However, instead of going all-in on China, I recommend spreading the exposure with a more diversified fund: the BlackRock Enhanced International Dividend Trust (BGY), part of my investment strategy.

This graphic tells a compelling story. While CHN and the Chinese-stock benchmark MCHI have shown declines over the past five years, BGY has risen with an annualized return of 7.4%. Additionally, BGY recently announced an increase in its monthly dividend, currently offering an attractive annualized yield of 9.2%, meaning investors are primarily receiving their returns through dividends.

Incorporating a strategy that allows us to make timely shifts between U.S. and international stocks can enhance our safety, returns, and income. For example, when U.S. stocks dip, we can utilize our dividends from BGY to invest in the Liberty All-Star Equity Fund (USA). Conversely, during down periods in international stocks, we can leverage USA’s higher dividend yield (currently at 9.9%) to reinvest in international opportunities.

This dual approach maximizes diversification while simultaneously creating a robust income stream, surpassing the typical strategies many investors engage in, such as buying low-yielding international and U.S. ETFs, which often lead to volatile price fluctuations without effective rebalancing.