|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 Brett Arends, The Wall Street Journal, 10/17/2014|
MarketMinder's View: Yep. Asset allocation is fundamental to long-term portfolio return. But after the mix of stocks, bonds, cash and other securities you use, in our view, the next most impactful thing is the category of those securities you pick. Valuations, including the Cyclically Adjusted Price-to-Earnings ratio (CAPE), aren’t long-term return drivers. They aren’t predictive of cycles or long-run returns, as illustrated by the 1990s—CAPE was above 20 as early as 1992 then. It was at the present level as early as 1996. CAPE was also above-average for pretty much all of the 1960s. While most P/Es illustrate sentiment, the CAPE is too distorted to even accomplish that. Because it mixes in earnings a decade old, the figure wraps in data that may be a full cycle behind. Many CAPE apologists excuse this by claiming it adjusts corporate results for economic cycles. But this is a statement that doesn’t pass the logic test: Stocks and corporate earnings are inherently tied to economic cycles. The macroeconomic picture matters a whole lot for individual company results, and ignoring this factor is a big mistake.
|By Ian Talley, The Wall Street Journal, 10/17/2014|
MarketMinder's View: The next time someone tries telling you the myth that foreigners are going to shun our debt or dump our debt or whatever, take a look at the actual data. Despite volatility over time, foreign demand for US debt is running high. How else can you see this more broadly? Interest rates, which are historically low today. Oh, and when they inevitably bring up the risk that foreigners fire sell those assets, ask them to consider two points: 1) Who are they selling to? For every seller, there is a buyer. And 2) It is highly unlikely some foreign nation is going to blow out a huge chunk of their foreign reserves desperately, which would probably cause them to take a loss. That is what we call, “Shooting thyself in thine foot.” (Not sure why we went all olde English, but you get the drift.)
|By Matt Levine, Bloomberg, 10/17/2014|
MarketMinder's View: The SEC has its first high-frequency trading prosecution win, and it seems justifiable to us. But this entertaining article highlights a few really sensible points on its road to wisely concluding, “The lesson here is something like: There are manipulative strategies, and there are good strategies, and it is not easy to tell them apart. You can tell them apart, probably, but you need to understand their purposes first. And dumb e-mails and nicknames can be a big help.” Aside from interesting and humorous, the discussion of a market maker’s role is top notch.
|By Juliet Chung and Vipal Monga, The Wall Street Journal, 10/17/2014|
MarketMinder's View: The ECB’s negative deposit rate was ostensibly put in place to spur lending—which the eurozone could truly use, given trillions worth of bank deleveraging the last few years. But merely penalizing banks for holding excess reserves doesn’t incent lending. It might incent holding something else (like government bonds). And when those plunge to negative short-term rates (likely partly as a result), then those for-profit banks likely just whack consumers, passing on costs in a tried and true capitalist practice. Now, the depositors paying this charge are presently large depositors (above €10 million), hedge funds, large businesses and the like, but their response is worth watching, too. All this highlights the fact that when you tell banks they could be shut if they don’t have big capital in a rather arbitrary stress test—as the ECB has—they will find ways to hold that capital. What banks really need to start lending is for stress tests to conclude and the cloud of regulatory uncertainty to clear.
Market Wrap-Up, Thurs Oct 16 2014
Below is a market summary (as of market close Thursday, 10/16/2014):
Global Equities: MSCI World (-0.2%)
US Equities: S&P 500 (0.0%)
UK Equities: MSCI UK (+0.2%)
Best Country: Canada (+1.7%)
Worst Country: Norway (-3.2%)
Best Sector: Energy (+1.3%)
Worst Sector: Telecommunication Services (-0.9%)
Bond Yields: 10-year US Treasurys rose by .02 to 2.16%
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.