|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 Eric Morath and Josh Mitchell, The Wall Street Journal, 10/22/2014|
MarketMinder's View: Attention Social Security recipients: As noted in this article, you will receive a 1.7% bump in payments in the next 12 months, based on annual CPI-W! (That’s the Consumer Price Index for Urban Wage Earners and Clerical Workers, the basis for the Social Security Administration’s cost-of-living adjustments.) Huzzah? Whether you think that a paltry sum or a big windfall, it is largely based on the still-tame inflation rates experienced in many parts of the world lately. However, the thesis offered here to explain this phenomenon (slow economic growth results in tepid wage growth, which means little inflation) was debunked almost half a century ago by Milton Friedman in papers like this one. Headline inflation is being weighed down by falling commodity (energy, food, raw materials) prices. Core inflation, still slow, is being weighed down by slow loan growth, which is the result of monetary policy decisions like quantitative easing, which flattened the yield curve, reducing banks’ loan profits and, hence, their willingness to make loans. Inflation is always and everywhere a monetary phenomenon, and without loan growth, the money supply doesn’t grow.
|By David Goodman, Lucy Meakin and Ye Xie, Bloomberg, 10/22/2014|
MarketMinder's View: So the hopelessly confused theory here is that now central banks' measures target weaker currencies so they can make their trading partners’ currencies rise, and we all know a rising currency is deflationary, so this is the latest fear-morph labeled a "currency war," a splashy name. But here is the reality: Most central banks' primary function is to target inflation, avoiding deflation and hyperinflation, if successful. So isn't this round of policy making just a (misguided) attempt to do that? Second, quantitative easing hasn't proven to be very inflationary in Japan, the US or UK. Why would it be different now? Third, inflation and currency values are not one-to-one, directly related. Inflation is an absolute phenomenon, currency values are always and exclusively relative. Hence, two countries could both experience high inflation or low inflation, yet one of the two would (assuming some movement) likely have a stronger currency than the other.
|By Andrey Ostrukh, The Wall Street Journal, 10/22/2014|
MarketMinder's View: Well, we are sure the sanctions are having an impact on Russia’s economy, which reportedly grew 0.0% in September. But we would humbly suggest that oil prices are a bigger deal than the largely toothless sanctions the West has put in place. When your economy is basically a one-trick pony, and that one-trick pony faces an enormous increase in the volume of tricks from other ponies, the price that pony can fetch for its trick likely falls. That is what is happening in the oil market today, and the oil industry is much more price sensitive than volume. This means the vast majority of Russia’s budget is hamstrung.
|By Dina Gusovsky, CNBC, 10/22/2014|
MarketMinder's View: The short answer, from an economic and market perspective, is no. China cannot replace the West as an export destination for Russia, and Russia cannot replace America and the West with China. What’s more, the 30-year Gazprom deal signed between Russia and China may be denominated in yuan, but that isn’t negative for the dollar. The yuan is a non-player on the global stage in terms of transactions denominated in it or its share of foreign currency reserves. But even if it were, there is no sign that would be a real threat to the US. The British pound is alive and well, yet it pales in comparison the US dollar on the global stage. Ditto for the euro. And the yen! Moreover, not mentioned here but often connected to this reserve-currency fear, is the fear such a move would jack up interest rates on US debt. But this ignores the fact Japanese, German, French and UK rates are as low as or lower than US, and none have the primary global reserve currency. To the extent more countries can trade without converting to USD, that is an economic plus for the world. The US government doesn’t get a brokerage fee or tax on the trade, and there is a buyer and seller in every transaction. This is just a ghost story, pure and simple.
Market Wrap-Up, Tues Oct 21 2014
Below is a market summary (as of market close Tuesday, 10/21/2014):
Global Equities: MSCI World (+1.5%)
US Equities: S&P 500 (+2.0%)
UK Equities: MSCI UK (+1.7%)
Best Country: Norway (+3.6%)
Worst Country: Japan (-1.4%)
Best Sector: Energy (+2.8%)
Worst Sector: Consumer Staples (+0.6%)
Bond Yields: 10-year US Treasurys rose by .02 to 2.21%
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.