|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 Sophia Yan, CNN Money, 10/21/2014|
MarketMinder's View: Yes, China’s economy is growing at a slower pace (7.3% y/y in Q3). And there is a chance China might not reach its 7.5% annual growth target. Should we be concerned? Not necessarily—China is still growing at a rate most countries would love. The hard landing so many fret still isn’t here. Plus, GDP growth alone isn’t the only factor to consider—the government has also been in the process of implementing reforms, which will likely be a long-term positive for China. For more, see Joseph Wei’s 08/07/2014 commentary, “China’s Balancing Act.”
|By Simon Kennedy, Bloomberg, 10/21/2014|
MarketMinder's View: “By estimating that zero stimulus would be consistent with a 10 percent quarterly drop in equities, they calculate it takes around $200 billion from central banks each quarter to keep markets from selling off.” So by starting from the presumption that the Fed’s actions are in fact stimulus, you find that the Fed has to do a lot to prop up stocks. But the problem isn’t the math, it’s the logic on this thesis, which starts from a fallacious point. Quantitative easing (QE) hasn’t been all that great for the economy—it weighed on long-term interest rates, decreasing banks’ profit margins. Banks had less incentive to lend, which meant money supply growth was painfully slow (which means not much new money could even have leaked into stocks, to the extent that was a thing at all—we think not so much). Now, maybe slow growth is good for stocks because it keeps worries higher for longer. That is possible. But it is equally possible faster growth would have benefited stocks more. Ultimately, this looks to us like trying to explain why markets bounced back the last few days, which presumes there was a fundamental reason they fell.
|By Isaac Arnsdorf and Bradley Olson, Bloomberg, 10/21/2014|
MarketMinder's View: Oil prices have fallen as of late. But concluding that a few weeks’ long blip will cause companies to change behavior and pump less seems like an awfully big leap. Oil firms do not respond to every little wiggle in oil prices real-time—nor can they. It isn’t that easy to switch production on or off. Lastly, recent oil price swings don’t necessary result from longer-term supply and demand fundamentals—sentiment can also drive short-term volatility. Plus, we are a bit skeptical of the notion prices at $80 a barrel are below firm’s shale breakeven points.
|By Peter Eavis, The New York Times, 10/21/2014|
MarketMinder's View: A couple of high ranking Fed honchos, New York Fed President William Dudley and Fed Governor Daniel Tarullo, have launched a bit of a political campaign aiming to refine the culture of big Wall Street firms, on the belief that this could prevent illegal or unethical practices, or just outright greedy behavior that “contributed to the  financial crisis.” Tarullo separately stated that Wall Street firms can’t just apply a “Check the box” regulatory structure. The fallout if they don’t? The two implied big firms will be broken up. However, completely unaddressed was the issue of small firm behavior, like Countrywide Financial Group, which we are told wasn’t good. Or the nonpublic, small firms in the S&L crisis. They do bad things too! And what about other industries? Shall we say, break up GM due to the recall issues it faced last year? Are there cultural issues there, too? We were told it was necessary to bail out GM in 2009 because the macroeconomic fallout would be immense. Which is too big to fail in a nutshell. Our point isn’t that bankers are the Partridge Family or something, but rather, that there are baddies in every industry. Banking isn’t special. Oh and greed had nothing to do with the crisis. The accounting rule Mr. Dudley loosely identified in early 2008 did. Regulators attempting to regulate corporate culture is a rather ridiculous notion.
Market Wrap-Up, Mon Oct 20 2014
Below is a market summary (as of market close Monday, 10/20/2014):
Global Equities: MSCI World (+0.8%)
US Equities: S&P 500 (+0.9%)
UK Equities: MSCI UK (0.5%)
Best Country: Japan (+3.8%)
Worst Country: Norway (-1.7%)
Best Sector: Consumer Discretionary (+1.4%)
Worst Sector: Energy (0.0%)
Bond Yields: 10-year US Treasurys fell by .04 to 2.19%
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.