|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 Neil Irwin, The New York Times, 07/30/2014|
MarketMinder's View: Well, there are caveats, for sure. But there usually are in any series as broad and wonky as GDP. The article notes 1.66 percentage points of growth came from inventories—which are open to interpretation as to what they say about Q2 growth—but doesn’t note that bare shelves subtracted 1.16 percentage points in Q1, largely caused by ice-jammed shipping routes. The article also doesn’t quantify the assumed boost from health care—just 0.08 percentage point (that’s it!)—which likely gets revised up when full data are in. Finally, it totally avoids the issue of an 11.7% import surge subtracting 1.85 percentage points from headline growth. GDP’s math tallies imports as a negative, but they actually show strong demand at home—which, you know, isn’t bad. We’d suggest this is just confirmation Q1 was a one-off and not something worse.
|By Matthew Lynn, The Telegraph, 07/30/2014|
MarketMinder's View: This pretty much sums it up: “The oil and gas fields generate a heck of a lot of money. Except the trouble is, you are not going to get any of it. Most of it will go to the Government and the exploration companies – and practically nothing will go to you. One reason the industry has developed so fast in the US is that under American law the oil and gas is owned by the people under whose land it is discovered. If a developer finds it under your property, you make a fortune. In this country, you only own the first few feet, which isn’t any use – the shale gas is a lot deeper than that.”
|By David Enrich, Gabriele Steinhauser and Matthew Dalton, The Wall Street Journal, 07/30/2014|
MarketMinder's View: The US and EU officially released details of their expanded sanctions on Russia tied to the ongoing Ukraine conflict. And, here again, the sanctions lack teeth and are more noteworthy, arguably, for what they omit than what they hit. As shown here, major Russian banks can’t issue long-term debt in either EU or US capital markets, but the banks targeted have relatively little debt due in the next nine months. Also, the US sanctions on banks miss Russia’s largest bank, which is majority state-owned, no less. Other measures taken include a ban on future arms sales and some energy technology.
|By Anatole Kaletsky, Reuters, 07/30/2014|
MarketMinder's View: If you are concerned that the Shiller Cyclically Adjusted Price-to-Earnings Ratio (CAPE) shows stocks are overvalued, we prescribe this excellent article. The CAPE’s theory is faulty, “… Arbitrary 10-year averaging takes no account of the length and depth of business cycles and makes no allowance for accounting write-offs. The Shiller price-earnings ratio will continue to be upwardly biased until 2019 because of the longest recession in U.S. history and the biggest-ever corporate write-offs then suffered by U.S. banks.” And isn’t accurate in practice: “But leaving aside the theoretical arguments, what about the practical usefulness of the Shiller ratio as an investment tool? Recent evidence is conclusive: For the past 25 years, the Shiller ratio’s signals have been almost uniformly wrong. Since 1989, the S&P 500 has multiplied eightfold, while total returns, including dividends, have increased the value of an average equity investment 12 fold.”
Market Wrap-Up, Wed July 30 2014
Below is a market summary (as of market close Wednesday, 07/30/2014):
Global Equities: MSCI World (-0.2%)
US Equities: S&P 500 (0.0%)
UK Equities: MSCI UK (-0.7%)
Best Country: Hong Kong (+0.6%)
Worst Country: Portugal (-3.3%)
Best Sector: Health Care (+0.3%)
Worst Sector: Utilities (-1.3%)
Bond Yields: 10-year US Treasurys rose by .1 to 2.56%
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.