|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 Michael Rapoport, The Wall Street Journal, 07/24/2014|
MarketMinder's View: Starting in 2018, the International Accounting Standards Board (IASB) will require non-US banks to book loan losses based on expected losses over the next 12 months—currently, banks don’t record losses until they actually happen. Its US counterpart, the Financial Accounting Standards Board (FASB), has proposed a stricter standard, forcing banks to book all losses expected over the lifetime of the loan up front. Problem is, you can’t forecast into perpetuity—how can a bank know today whether a new 30-year mortgage will ever default?—so pricing a loan for some far-future possibility may yield bizarre results. However, we don’t think this is a huge negative for Financials. The rule operates on banks’ own expectations of loan losses, not market prices a la FAS 157. Mark-to-forecast seems a far better standard since it’s tied directly to banks’ primary business, lending, and not the market’s occasionally irrational pricing of some illiquid assets they might hold on their balance sheet.
|By Ian Wishart and James G. Neuger, Bloomberg, 07/24/2014|
MarketMinder's View: Color us skeptical on the likelihood these proposals become actual sanctions: "The options in the document for responding to Russia’s intimidation of Ukraine included something for virtually every EU government to dislike. France has held out against an arms embargo, German industry fears for its exports to Russia, Britain and Cyprus have been reluctant to scare away wealthy Russian investors, and Hungary has opposed wider sanctions altogether.” And all these countries (and 23 more) must agree on any measures enacted. That’s, like, hard. For reference: So far, the sanctions the US and EU have imposed on Russia—largely targeting individuals and specific companies—have been fairly muted.
|By Megan McArdle, Bloomberg, 07/24/2014|
MarketMinder's View: “Food and energy loom disproportionately large in the budgets of retirees. They’ve already acquired a lot of stuff, so they’re less apt to get excited about fantastic deals on television sets and furniture manufactured in China. On the other hand, they buy food and gas and medicine every month. When they see how much those expenses carve out of their income, they think, ‘My income is not keeping up,’ and the idea that the government is using the wrong inflation index seems like a reasonable explanation for why it’s so hard to make their money stretch. But however compelling this explanation may seem, it’s wrong. The government knows about food and oil prices. And it’s taking them into account when it calculates your Social Security check.” For more, see our 06/30/2014 commentary, “Should the Fed Hike Rates to Make It Rain?”
|By David Gelles, The New York Times, 07/24/2014|
MarketMinder's View: Here be the latest on this protectionist solution in search of a problem, which we covered in detail last week. Treasury officials are pressing Congress to pass a law effectively banning “inversion” M&A deals that would apply retroactively, likely stripping at least some recently agreed-to deals of their tax benefits. Democratic Senators support the notion, but Republican Senators don’t want to backdate a crackdown. Perhaps they find a middle ground, but even if this clears the Senate, passing the House is a tall order. In our view, that’s a plus. Protectionism is a negative, and an inversion smackdown is simply protectionism dressed as patriotism. Retroactive tax grabs are also no bueno—they undermine confidence in America as a good place to do business (for an extreme example, see businesses’ reaction to India’s recent move to backdate a foreign merger supertax to the 1960s). Just because we’ve done it before, as this piece documents, doesn’t mean it’s wise to do it again.
Market Wrap-Up, Thurs July 24 2014
Below is a market summary (as of market close Thursday, 07/24/2014):
Global Equities: MSCI World (+0.1%)
US Equities: S&P 500 (+0.1%)
UK Equities: MSCI UK (-0.1%)
Best Country: Portugal (+2.3%)
Worst Country: Japan (-0.5%)
Best Sector: Financials (+0.5%)
Worst Sector: Industrials (-0.2%)
Bond Yields: 10-year US Treasurys rose by .04 to 2.51%
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.