|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 Alan S. Blinder, The Wall Street Journal , 10/30/2014|
MarketMinder's View: So all the eurozone needs is Germany to stop being a stickler with the ECB’s purse strings, allow various “unconventional stimulus programs” and the region will be back on a sustainable path of economic growth? Well that’s simple! After all, we saw how fiscal and monetary stimulus returned the “economic powerhouse” label back to Japan. Errrrr. Wait. Japan remains in an economic malaise despite having the most aggressive monetary easing in the developed world and repeat fiscal stimulus. So maybe it isn’t so simple? Besides, most of the austerity in the eurozone has been incremental tax hikes, not huge spending cuts, so the German approach doesn’t really seem to be dominating the landscape. Heck, many nations missed deficit targets in recent years. We would suggest the structural reforms this article downplays plus a good solid dose of deregulation and less shifting rules around banking would probably do more over time than allowing France to spend a wee bit more.
|By Russell Gold, Erin Ailworth and Benoit Faucon, The Wall Street Journal , 10/30/2014|
MarketMinder's View: As this piece nicely illustrates, fears that falling oil prices will put the US’s spectacular energy boom at risk are overwrought, as many firms can remain profitable at even lower prices. That isn’t to say some companies aren’t feeling pain, though—smaller companies drilling in areas with higher costs may need higher prices to break even. But it will take time for that effect to be truly felt, and it seems unlikely (as of now) to really hit the US’s largest shale fields, like the Bakken and Eagle Ford. For more, see our 10/29/2014 commentary, “Falling Oil Prices: Consumers’ Boon, Producers’ Bust?”
|By Staff, The Wall Street Journal , 10/30/2014|
MarketMinder's View: Though many have extolled the Fed’s quantitative easing (QE) program as a success, this take is sensibly skeptical. For one, the Fed’s bond buying may be over, but its balance sheet isn’t about to be wound down any time soon—QE’s effects will remain for a while. And two, though some point to the US’s lower unemployment and faster economic growth compared to Europe as evidence of QE’s effectiveness, this is a misleading comparison. US growth (and hiring) actually picked up as slower bond buying became a reality. Additionally, consider these two counterpoints: Japan and the UK. Japan used QE from 2001 to 2006, and yet trailed most developed nations’ growth and market returns over that period. It is also employing it on a vast scale (relative to GDP) today, yet the economic outlook is murky at best. Second, UK growth improved after it stopped its QE program—which seemingly corroborates the US’s acceleration when tapering neared. Finally, loan growth and economic growth are slow in this cycle—which is supported by roughly a century of theory stating that the money supply and yield curve are keys to growth. QE disavowed those lessons, instead fixating on low rates to spur demand, supply be damned. All in all, QE’s negatives seem to outweigh its positives.
|By Martin Crutsinger, Associated Press, 10/30/2014|
MarketMinder's View: First, the data: Q3 US GDP rose at an annual rate of 3.5%, led by consumer spending, exports and business investment. Wheeee! But before getting too high off this growthy-sounding number, a caveat—this is the first estimate of Q3 GDP. The first estimate of Q1 2014 GDP initially showed 0.1% annual growth, but that has since been revised to a -2.1% annual contraction. Now we aren’t trying to be a wet blanket about Q3 GDP—it could get revised higher like Q2 GDP was (first estimate of 4.0% to current estimate of 4.6%). But for investors, this backward-looking figure merely confirms what stocks have already moved on—the US economy is growing nicely, a leader in the developed world.
Market Wrap-Up, Thurs Oct 30 2014
Below is a market summary (as of market close Thursday, 10/30/2014):
Global Equities: MSCI World (+0.2%)
US Equities: S&P 500 (+0.6%)
UK Equities: MSCI UK (-0.7%)
Best Country: Denmark (+2.0%)
Worst Country: Portugal (-3.1%)
Best Sector: Health Care (+1.3%)
Worst Sector: Materials (-0.9%)
Bond Yields: 10-year US Treasurys fell .01 to 2.31%
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.