|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 Allan S. Roth, The Wall Street Journal, 11/26/2014|
MarketMinder's View: Some good, some less good here. We’ll start with the less good, because we feel like being Grinchy today: Rebalancing is quite often synonymous with market timing, unless you have a very rigid schedule you stick to. Too many folks think rebalancing means, “This category did really well, so I should sell some of it and plug the proceeds into this other thing.” Which is all a backward-looking, performance-only based decision that doesn’t account for the fact category outperformance can persist for long, long periods. In our view, your foreign versus domestic allocation should really reflect your outlook for various regions. Now then, the non-Grinchy stuff: “The diversification argument is simple. Living in a global economy as we do, I wouldn’t consider limiting my stock buying to only my home state or country, and neither should you. In fact, I’d diversify into interstellar stock markets if I could. The argument that we get enough international exposure by owning U.S. stocks which do business overseas is flawed, and gets me to my second argument, market timing.”
|By Paul Vigna, The Wall Street Journal, 11/26/2014|
MarketMinder's View: Well, maybe it is and maybe it isn’t. However, we feel compelled to point out the obsession over Black Friday and Cyber Monday as indicators of how retail sales will go is amazingly overdone. Public service message: Black Friday and Cyber Monday aren’t meaningful for investors—too myopic—and they aren’t indicative of which way holiday spending goes in total. Which itself is awfully myopic for longer-term investors to consider heavily.
|By Alan Kohler, The Australian, 11/26/2014|
MarketMinder's View: Well, not really. It’s causing low inflation. This article is a totally mixed bag, but it does highlight one common confusion around deflation: the notion it is always bad. It isn’t. Deflation that occurs as a result of a bank panic or monetary policy error probably is (though it usually follows the onset of those factors). Deflation that occurs because of a production surge (a la the industrial revolution) is not at all bad. Today, we have some modestly deflationary monetary policy (not hugely so) in quantitative easing (QE), which discourages lending through flattening the yield curve. But arguably a bigger factor is the massive increase in commodity production, which has flattened prices for oil, iron ore, copper and more. But again, we don’t have deflation today, and with the US ending QE, one major deflationary pressure has been alleviated.
|By Angela Monaghan, The Guardian, 11/26/2014|
MarketMinder's View: For those of you who don’t follow econo-talk closely, here is what’s up: After the crisis, the policymaking “elite” in Britain decided the economy’s problem was it was too reliant on the consumer to sustainably grow. So instead, they promoted a bunch of policy positions and talked about targeting increased exports and business investment, to supposedly put the UK economy on more solid footing. Now, nevermind that UK GDP growth has been among the fastest in the developed world for about two years now, underpinned largely by consumer spending. Instead, consider the general operating thesis here: That exports and business investment, two very volatile economic metrics, are more “sustainable” than consumer spending, which is stable by contrast. Suffice it to say, the logic of this plan has never been exactly clear to us. But also, business investment’s 0.7% dip follows a string of fairly positive quarters, and exports have been weak throughout the UK’s expansion. So we don’t really think this is so unsustainable after all.
Market Wrap-Up, Tues Nov 25 2014
Below is a market summary (as of market close Tuesday, 11/25/2014):
Global Equities: MSCI World (+0.2%)
US Equities: S&P 500 (-0.1%)
UK Equities: MSCI UK (+0.2%)
Best Country: Ireland (+2.0%)
Worst Country: New Zealand (-2.7%)
Best Sector: Consumer Discretionary (+0.7%)
Worst Sector: Energy (-1.2%)
Bond Yields: 10-year US Treasurys fell .05 to 2.26%
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.