|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 Enda Curran, The Wall Street Journal, 08/26/2014|
MarketMinder's View: Why? “Because borrowing costs for European banks are cheaper now than they were immediately following the eurozone crisis, they can lend more. And in some cases, the premium offered by emerging-market Asian borrowers can be higher than in Europe”—or, more simply, it’s more profitable. Now, this is happening already, with the ECB’s stress tests and asset quality review ongoing—the high quality of Emerging Asia’s biggest companies makes the reward worth the risk. If the ECB starts quantitative easing (QE) and flattens eurozone yield curves further, it wouldn’t surprise us if this trend continued as lending outside Europe became even more profitable on a relative basis. Count this as one of several reasons we don’t think QE would do much for the eurozone economy.
|By Zachary Karabell, Slate, 08/26/2014|
MarketMinder's View: We don’t agree with every nuance of this article, but the general thrust—that the broad investing public has a bit of an obsession with all things central bank—is sound. Our main criticism is it just doesn’t go far enough: Faith in the Fed as the savior in 2008 is utterly misplaced and backwards; faith in QE, in our view, is wrong on theory and effect. They’re now supposed to employ macroprudential regulation to deflate bubbles, but there is no evidence they’ve ever identified one. The Fed isn’t all bad, mind you, and we’re not calling for a gold standard or something. But the degree of blind faith folks place in this institution vastly exceeds what’s warranted by history.
|By Alison Griswold, Slate, 08/26/2014|
MarketMinder's View: Nothing magical about the S&P 500 surpassing 2,000. We’ve seen handfuls of round-number milestones during this bull market—the S&P reaching 1,600 in May 2013, 1,700 in August 2013, 1,800 in November 2013 and 1,900 in May 2014—and we could see many more. We don’t really know what it means to call a round number an important “psychological marker,” which sounds mostly like searching for meaning in all-time highs. Like this article using the 2,000 milestone as an opportunity to point to valuations—claiming stocks are “too expensive” and that they can’t keep rising forever. Their evidence? The cyclically adjusted price-to-earnings ratio, of course! Which wasn’t designed to forecast cyclical direction and doesn’t do it well, either.
|By Saabira Chaudhuri, The Wall Street Journal, 08/26/2014|
MarketMinder's View: So some are predicting the opaque back-and-forth over Dodd-Frank’s living will requirement will prompt banks to shed operations left and right, and there is some evidence this is already happening. Whether it escalates is all very speculative, but we have to wonder: One big reason banks have multiple business lines is to diversify their revenue sources—that way their eggs aren’t all in one basket. If they become less diverse in order to avoid the Fed/FDIC’s wrath when the next round of living wills are judged next year, doesn’t that kind of make the financial system less safe, not more? Especially since the business units they’re selling are—quite logically—the most profitable ones? We aren’t saying this takes down the banking system or anything, but it seems like a bizarre approach.
Market Wrap-Up, Monday Aug 25 2014
Below is a market summary (as of market close Monday, 08/25/2014):
Global Equities: MSCI World (+0.5%)
US Equities: S&P 500 (+0.5%)
UK Equities: MSCI UK (+0.1%)
Best Country: Italy (+2.1%)
Worst Country: Australia (-0.2%)
Best Sector: Energy (+0.8%)
Worst Sector: Information Technology (+0.2%)
Bond Yields: 10-year US Treasurys fell .02 to 2.39%
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.