Between early 2023 and mid-2024, the bulls were in control on Wall Street. The rise of artificial intelligence (AI), the return of stock split euphoria, and better-than-expected corporate earnings/economic data helped all three major stock indices hit multiple record highs.

But as history has shown time and again, the stock market does not move upwards in a straight line. Recently, the growth-oriented Nasdaq-Composite During the correction phase, the index fell by almost 1,400 points, or around 8% of its value, in the first three trading days of August.

Image source: Getty Images.

The ingredients for a stock market crash or bear market decline Do exist – and crashes have historically always represented an excellent opportunity for long-term investors to open positions in high-quality companies or to increase their existing holdings.

While I have a number of stocks on my buy radar in case the general sell-off accelerates, I am keen to triple my existing stake in a virtually unknown company that is paying a market-shattering 11% yield.

The ingredients for a stock market crash are there

Let me start this discussion by pointing out that no economic data point, metric or forecasting tool can predict the near-term future with 100% accuracy. However, there are certain metrics and events that strong correlates with significant up or down moves in the broader market throughout history – and I’m a big fan of history rhyming on Wall Street.

US M2 money supply data from YCharts.

For example, over the past two years we have seen the first significant decline in the U.S. M2 money supply since the Great Depression. M2 money supply includes everything in M1 (cash and coin in circulation and demand deposits in a checking account) and includes savings accounts, money market accounts, and certificates of deposit (CDs) under $100,000.

Most economists pay little attention to the money supply because it has been rising so steadily for 90 years. That is, an expanding economy needs more capital to facilitate transactions. However, since its peak in April 2022, the M2 money supply has fallen by more than 3%.

Last year was only the fifth time in 153 years that M2 declined by at least 2% year-on-year. The previous four cases, which occurred between 1878 and 1933, coincided with periods of economic depression and double-digit unemployment rates. While a depression high Although unlikely today, a decline in discretionary spending caused by a reduction in M2 suggests that a recession is imminent.

S&P 500 Shiller CAPE ratio data by YCharts.

In addition, the Shiller price-to-earnings (P/E) ratio of the S&P 500 indicates that stocks are historically expensive. The Shiller P/E ratio is also often referred to as the cyclically adjusted price-to-earnings ratio or CAPE ratio.

The Shiller P/E ratio, which is based on average inflation-adjusted earnings over the past ten years, was 34.47 on August 9, roughly double its average of 17.14 from January 1871.

But the more troubling aspect of the S&P 500’s Shiller P/E ratio is the broader market’s reaction to instances where it exceeded 30. This has only happened six times in the past 153 years. After the previous five instances, Wall Street’s major stock indexes lost between 20 and 89 percent of their value. In other words, investors will not tolerate excessive valuations over long periods of time.

The M2 money supply, the Shiller P/E ratio and other forecast indicators strongly suggest that a bear market or even an outright crash could be imminent.

Image source: Getty Images.

This under-the-radar stock with an 11% yield is a phenomenal buy in times of panic

If the stock market crashes, the virtually unknown, extremely high-yielding stock I would like to triple my position in is Business Development Company (BDC). PennantPark floating rate capital (PFLT 1.29%).

A BDC is a company that invests in debt or equity (common and/or preferred stock) of middle-market companies — typically small and micro companies that have not yet proven themselves. Although PennantPark held nearly $209 million in various preferred and common stock positions as of June 30, its $1.45 billion in senior secured debt makes it a primarily debt-focused BDC.

The benefit of focusing on debt is returns. Because most middle market companies have limited access to traditional financial services, PennantPark is typically able to generate loan returns that are well above the market average. As of mid-2024, the company generated a weighted average return of 12.1% on debt investments.

More importantly, PennantPark Floating Capital’s entire debt portfolio is floating rate. The most aggressive rate hike cycle in four decades has helped PennantPark’s weighted average return on debt investments increase by 470 basis points since September 30, 2021. Even if the country’s central bank is widely expected to initiate a rate cut cycle next month, the weighted average return on the company’s debt investments will be several times higher than the prevailing inflation rate.

The biggest concern for a small-cap BDC that focuses its lending on generally untested companies is how well those borrowers will fare if the U.S. economy weakens. Fortunately, PennantPark’s management team has taken a number of steps to properly screen its loans and protect its capital.

For example, the company’s $1.66 billion investment portfolio, which also includes equity investments, is spread across 151 companies. With an average investment size of “only” $11 million, no single debt or equity deal is crucial to the company’s success.

In addition, all but $1.2 million of PennantPark’s debt securities, totaling $1.449 billion, are senior secured. In the unlikely event that one of the company’s borrowers files for bankruptcy protection, the senior secured creditors will have first priority for repayment.

The steps PennantPark has taken to carefully screen middle-market companies and protect its capital resulted in a relatively low default rate of 1.5 percent of the portfolio’s cost base as of June 30.

The company’s valuation is the final piece of the puzzle that would make me triple my existing stake. As of the close on August 9, shares were trading 4.4% below their GAAP net asset value (NAV) per share of $11.34. It is not uncommon for short-lived, emotion-driven panic selling during bear markets and stock market crashes to briefly push companies like PennantPark well below their NAV. Most of the time, BDCs’ share price fluctuates very close to their NAV.

PennantPark Floating Rate Capital should have no problems meeting its monthly (Yes, monthly!) distribution of $0.1025 per share, which currently corresponds to an annual yield of 11.4 percent.

Since I have ample reserves, I would welcome the opportunity to triple my position in this under-the-radar income powerhouse.