|By Fisher Investments Research Staff, 11/26/2013|
With interest rates on everything from savings accounts to junk bonds at or near generational lows, many income-seeking investors are looking for creative or, to some, exotic means of generating cash flow. Some are turning to a relatively little-known type of security—master limited partnerships (MLPs). MLPs may attract investors for a number of reasons: their high dividend yields and tax incentives, to name a couple. But, like all investments, MLPs have pros and cons, which are crucial to understand if you’re considering investing in them.
MLPs were created in the 1980s by a Congress hoping to generate more interest in energy infrastructure investment. The aim was to create a security with limited partnership-like tax benefits, but publicly traded—bringing more liquidity and fewer restrictions and thus, ideally, more investors. Currently, only select types of companies are allowed to form MLPs—primarily in energy transportation (e.g., oil pipelines and similar energy infrastructure).
To mitigate their tax liability, MLPs distribute 90% of their profits to their investors—or unit holders—through periodic income distributions, much like dividend payments. And, because there is no initial loss of capital to taxes, MLPs can offer relatively high yields, usually around 6-7%. Unit holders receive a tax benefit, too: Much of the dividend payment is treated as a return of capital—how much is determined by the distributable cash flow (DCF) from the MLP’s underlying venture (e.g., the oil pipeline).
When the Fed kept quantitative easing (QE) in place last week, US investors weren’t the only ones (wrongly) breathing a sigh of relief. Taper terror is fully global! In Emerging Markets (EM), many believe QE tapering will cause foreign capital to retreat. Some EM currencies took it on the chin as taper talk swirled over the summer, and many believe this is evidence of their vulnerability—with India the prime example as its rupee fell over 20% against the dollar at one point. Yet while taper jitters perhaps contributed to the volatility, evidence suggests India’s troubles are tied more to long-running structural issues and seemingly erratic monetary policy—and suggests EM taper fears are as false as their US counterparts.
The claim QE is propping up asset prices implies there is some sort of overinflated disconnect between Emerging Markets assets and fundamentals—a mini-bubble. Yet this is far removed from reality—not what you’d expect if QE were a significant positive driver. Additionally, the thesis assumes money from rounds two, three and infinity of QE has flooded into the developing world—and flows more with each round of monthly Fed bond purchases. As Exhibit 1 shows, however, foreign EM equity inflows were strongest in 2009 as investors reversed their 2008 panic-driven retreat. Flows eased off during 2010 and have been rather weak—and often negative—since 2011.
Exhibit 1: Emerging Markets Foreign Equity Inflows
With investors expecting the Fed to end quantitative easing soon, the yield spread is widening—fuel for stocks! Photo by Alex Wong/Getty Images.
Since 1932, the average S&P 500 bull market has lasted roughly four and a half years. With the present bull market a hair older than the average—and with domestic and global indexes setting new highs—some fret this bull market is long in the tooth. However, while bull markets die of many things, age and gravity aren’t among them. History argues the fundamentals underpinning this bull market are powerful enough to lift stocks higher from here, with economic growth likely to continue—and potentially even accelerate moving forward as bank lending increases.
|By Christo Barker, 10/10/2013|
While the rest of the country fretted over taper terror, government shutdown and debt ceiling limits, the Federal Reserve tested its Fixed Rate Full-Allotment Reverse-Repo Facility (a mouthful—let’s call it FARRP) for the first time September 24. FARRP allows banks and non-banks, like money market funds and asset managers, to access Fed-held assets—i.e., the long-term securities bought under the Fed’s quantitative easing—via securities dealers’ tri-party repo (and reverse-repo) market for short-term funding. (More on repos to follow.) FARRP aims to address what many feel is a collateral shortage in the non-bank financial system caused by too much QE bond buying concentrating eligible collateral on the Fed’s balance sheet, where it doesn’t circulate freely. As a result, many private sector repo rates turned negative. But, should FARRP be fully implemented, the facility could actually hinder some assets (in this case, high-quality, long-term collateral like bonds) from circulating through the financial system—much like quantitative easing (QE) locked up excess bank reserves. A more effective means of freeing collateral in the repo market is tapering the Fed’s QE.
Repurchase agreements, or repos, are used to generate short-term liquidity to fund other banking or investment activity—a means to move liquidity (cash) from one institution to another. In a repo, one party sells an asset—usually long-term debt—agreeing to repurchase it at a different price later on. A reverse repo is, well, the opposite: One party buys an asset from another, agreeing to sell it back at a different price later. In both cases, the asset acts as collateral for what is effectively the buyer’s loan to the seller, and the repo rate is the difference between the initial and future sales prices, usually expressed as a per annum interest rate. The exchange only lasts a short while—FARRP’s reverse repos are overnight affairs to ensure markets are sufficiently funded. In the test last Tuesday, the private sector tapped the facility for $11.81 billion of collateral—a small, but not insignificant, amount.
FARRP’s first round is scheduled to end January 29, and during that time, non-bank institutions can invest between $500 million and $1 billion each at FARRP’s fixed overnight reverse-repo rates ranging from one to five basis points. A first for repo markets: Normally, repo and reverse-repo rates are free-floating, determined by market forces. Another of FARRP’s differentiating factors is private-sector need will facilitate reverse-repo bids instead of the Fed. Ideally, FARRP’s structure will encourage unproductive collateral to be released back into the system when it’s most needed—and new sources of collateral demand may help ensure this. Swaps, for example, are shifting to collateral-backed exchanges due to Dodd-Frank regulation—meaning more collateral will be needed to back the same amount of trading activity. Collateral requirements for loans will likely also rise.
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|By Joshua M. Brown, The Reformed Broker, 10/23/2014|
MarketMinder's View: While the takeaway—there is no permanent must-own stock on Wall Street—is fine, we’d suggest this is too myopic and narrow to reach big conclusions. A third of the Dow is only 10 stocks, and we’re talking about a 12-month period. Some of those stocks will be oil and commodity-oriented too. Those aren’t facing issues specific to their firm, but rather, the industry-wide headwind of falling oil prices. Sure, some others face company specific issues. But the article sourced here doesn’t prove the point. Oh and besides—the biggest firms in the world, those many would consider blue chip, have blown small caps out of the water over the last 12 months.
|By Shobhana Chandra, Bloomberg, 10/23/2014|
MarketMinder's View: The Conference Board’s US Leading Economic Index (LEI) rose 0.8% in September, with nine out of 10 indicators—led by the interest rate spread—increasing. The one negative contributor? Average consumer expectations for business conditions, which are among the most limited components in this forward-looking indicator—-surveys tell you only how folks felt on a given day. US LEI has now increased in seven of the past nine months, and no US recession has begun while LEI is rising in its 50+ year history. Huzzah!
|By Max Colchester and Tommy Stubbington, The Wall Street Journal, 10/23/2014|
MarketMinder's View: While the ECB’s much-anticipated stress test results will be made public on Sunday, banks are being notified privately today. Though it’s amusing to imagine failing banks’ reactions—we’re picturing a shamed student who has to get his report card signed by his parents—experts expect most banks to pass, considering they spent the past year deleveraging and hoarding capital in preparation for this assessment. Though we wouldn’t be surprised if a high profile name or two failed, the completion of the ECB’s stress tests is a positive development. In our view, this regulatory headwind has been the primary culprit for weak eurozone lending, which should start to improve with this uncertainty passing.
|By James Titcomb, The Telegraph, 10/23/2014|
MarketMinder's View: Starting in January 2015, the BoE will deal with failing banks in a three-step process. Step one: Stabilize the firm. Freeze its stocks and bonds from trading, give it a lifeline for funding. The BoE will directly step in, move deposits to a solvent third party and/or bail-in bondholders, converting debt to equity. Step two: Restructuring, which attempts to fix the causes of failure, including firing the current executives (presumed to be to accountable for the failure). The BoE will replace them with outside selections made in roughly 48 hours (the BoE thinks it has a great Human Resources and Recruiting department). Then, the third step is resolution, in which either the bank ceases to exist or will exit liquidity support. A few questions about this plan: 1) What if the failure doesn’t happen on a timeline? All the steps here presume the bank is deemed to have failed after shares are halted from trading and an assessment is done. Then over “Resolution Weekend” new directors are selected, deposits moved, bail-ins are decided on, etc. Busy weekend! What if they don’t get that time? 2) How will they determine a failure is looming? Who’s to say the BoE’s hand-selected choices will make the best decisions? What if the failures are not exclusively the fault of management—but rather, the unintended consequence of regulatory changes, as in 2008? Or monetary decisions, like in the early 1930s? Who gets fired then?
Market Wrap-Up, Wed Oct 22 2014
Below is a market summary (as of market close Wednesday, 10/22/2014):
Global Equities: MSCI World (-0.2%)
US Equities: S&P 500 (-0.7%)
UK Equities: MSCI UK (-0.1%)
Best Country: Japan (+2.0%)
Worst Country: Canada (-1.5%)
Best Sector: Utilities (+0.6%)
Worst Sector: Energy (-1.3%)
Bond Yields: 10-year US Treasurys remained at 2.21%
Editors' Note: Tracking Stock and Bond Indexes
Source: Factset. Unless otherwise specified, all country returns are based on the MSCI index in US dollars for the country or region and include net dividends. Sector returns are the MSCI World constituent sectors in USD including net dividends.