|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.
Get a weekly roundup of our market insights.Sign up for the MarketMinder email newsletter. Learn more.
|By Neil Irwin, The New York Times, 10/29/2014|
MarketMinder's View: An impressive collection of misperceived data and theories about the Fed’s quantitative easing (QE), in pictures! We’ll go chart by chart, for your convenience.
Chart 1—Fed Balance Sheet: Yep, it’s up a lot. The taper is also not going to bring it down, as they intend to reinvest maturing principal and no bonds are being sold. The discussion here is accurate.
Chart 2—Mortgage-Backed Securities: Yep, they bought ‘em.
Chart 3—Corporate Bond and Mortgage Rates: Yep, they’re down. Though, we’d note that corporate bonds have not been targeted outright by QE.
Here is where we get wackier.
Chart 4—The Cyclically Adjusted P/E Ratio (CAPE) is at Pre-Bust Levels: It is, but this has next to nothing to do with QE, is a poor measure of valuations and isn’t a timing tool for investing. Since it blends together earnings from the last decade, it’s currently more inflated by the recession’s slashing the “E” in CAPE than anything with QE. Stocks aren’t expensive by historical standards using better measures, and even if they were, they could still rise.
Chart 5: Inflation. QE, particularly QEs 2 and 3, is deflationary. It weighs on long-term interest rates, narrowing the spread between short- and long-term yields. This spread is a key determinant of banks’ lending profits. More narrow equals less profitable, and as a result, less plentiful lending. Those low rates discouraged loan supply. Without lending, the Fed is powerless to boost money supply and inflation.
Chart 6: Potential GDP and GDP: GDP is an imperfect reflection of the economy, and potential GDP is an imperfect extrapolation of the trend of this imperfect reflection. None of this is telling.
Chart 7: Jobs follow growth, growth has been slow in this cycle, in part due to QE.
Loan growth in this cycle has been the slowest of any on record. Growth has been too. That is not coincidence, and QE is partly to blame, not laud.
|By Ambrose Evans-Pritchard, The Telegraph, 10/29/2014|
MarketMinder's View: An enjoyable read, but the thesis here is off and the evidence less convincing when you put it under a finer lens. The Riksbank cut rates to zero because it seeks higher inflation, which is the primary role of most central banks the world over. They didn’t explicitly target a weaker currency, the aim of a currency war. But even if they did, you don’t win a currency war—you win and lose, because import prices rise, impacting businesses’ and consumers’ bottom lines. Finally, the notion, “The Riksbank faces an acute dilemma, forced to pick between the competing poisons of deflation or an asset boom” is great writing but off-target analysis. For one, they weren’t using rates to control housing prices (the perceived asset boom), they were using macroprudential policies (their own flavor of wrong). But that is also a false either/or. The debt to disposable income figures cited here as “jumping” from 120 percent to 175 percent over the past twelve years as evidence of the bubble amount to a compound annual growth rate of less than 2.5 percent per year. That’s it folks, 2.5 percent. Never mistake high quality wordplay employing a certain dramatic flair for fact-packed analysis.
|By Paul Vigna, The Wall Street Journal, 10/29/2014|
MarketMinder's View: Full disclosure: We are not fans of technical analysis. But this article actually just completely argues against itself, illustrating why we don’t buy into the predictive quality of lines on a page. We are told by one devotee that, “Well, those two key technical markers having been hit, there isn’t much upon which traders can key, he said. ‘They are behind us, leaving no live formations to key off of. That and support being light means that we should be prepared for the expected volatility in the day’s final two hours.’” But here is the thing: The rest of the article shows you that technical analysis didn’t foretell anything that has happened over the last two weeks or even longer. But now we’re in uncharted territory. What were we in then? Here are the facts: Technical analysis relies on devotees’ interpretation of past price levels. But stocks aren’t serially correlated, so you can never predict returns by “drawing lines on charts and extrapolating them into the future.”
|By Szu Ping Chan, The Telegraph, 10/29/2014|
MarketMinder's View: This is a “timebomb” with an exceptionally long, slow-burning wick to ignite what could be a big ol’ dud anyway. The argument is similar to the one offered in the US about the government’s “unfunded liabilities”—long-term forecasts and projections of the impact of entitlement spending on the public debt. Suffice it to say, we strongly doubt any of the forecasts here for what UK debt-to-GDP will look like in 2061 are very reliable. But even if they are, and their worst case scenario comes to pass, we’d like to point out Britain has had debt exceeding 200% of GDP before—when it had an empire the sun never set on. Japan, by the way, has 220% debt-to-GDP right now. Now Japan isn’t exactly a shining economic star, but it isn’t because of their debt—the neo-mercantilist, anti-competitive tendencies create that issue. Britain doesn’t have those factors. Besides, we’ve seen many nations reform pensions and other benefits in recent years, and there is no reason the UK couldn’t do so at any point in the next 47 years if it were necessary to avoid a potentially bad 2061.
Market Wrap-Up, Wed Oct 29 2014
Below is a market summary (as of market close Wednesday, 10/29/2014):
Global Equities: MSCI World (+0.1%)
US Equities: S&P 500 (-0.1%)
UK Equities: MSCI UK (+0.8%)
Best Country: Japan (+1.4%)
Worst Country: Spain (-1.4%)
Best Sector: Energy (+0.4%)
Worst Sector: Utilities (-0.3%)
Bond Yields: 10-year US Treasurys rose .02 to 2.32%
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.