|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 Morgan Housel, The Wall Street Journal, 10/24/2014|
MarketMinder's View: Parts of this are a bit buy-and-holdy, and it downplays the opportunities to capitalize on trends that arise throughout the market cycle. But those wee drawbacks aside, it is a handy look at some of the ways our brains and feelings trick us. These are four lessons every investor who isn’t a robot or otherwise lacks an emotional “off” switch would benefit from learning.
|By Jason Zweig, The Wall Street Journal, 10/24/2014|
MarketMinder's View: The sciencey stuff in the first half is interesting, but probably not actionable. The second half, however, is full of good solid sense about how people err in perceiving their own ability to withstand market volatility—and what they can do about it. Why is this important? “For most investors, the most damaging risk is probably … ‘deviating from your long-term plan in pursuit of short-term emotional comfort in a time of unease.’” The four-part questionnaire at the end can help you avoid this trap.
|By Ruth Mantell, MarketWatch, 10/24/2014|
MarketMinder's View: This piece highlights an NBER paper claiming stocks do best under Republican governments but the economy does best under Democrats. This. Is. Hogwash. Stocks don’t prefer either party. Of the 13 bear markets since 1926, six started on a Democratic President’s watch and seven started under a Republican. The reason one is higher than the other is that there is an odd number. Differing economic growth rates during Democratic and Republican administrations stems from countless variables, many beyond the President’s control. Politically, we think the biggest swing factor is gridlock. When Congress can’t agree on anything, they can’t reshape property rights, regulation or the distribution of resources and capital. Stocks usually love the stability of the status quo.
|By Matt O’Brien, The Washington Post, 10/24/2014|
MarketMinder's View: No it didn’t. It just got argued, once again, which doesn’t make it remotely accurate. This time, two economists tried to model “secular stagnation” and came up with three reasons why it’s a thing and could stay a thing. Those reasons are household deleveraging, inequality and declining population growth. Let’s take a look. Households did deleverage quite a bit after the financial crisis, but borrowing bounced last year and is accelerating. Not that you need higher household borrowing and less saving to boost interest rates and boost growth—a bizarre thesis considering the paper goes on to argue we need super low rates to boost growth. (When arguments argue against themselves, they fail the logic test.) Moving to inequality, we have never seen reliable evidence it is widening. Most studies use pre-tax, pre-entitlement median household income. Which doesn’t account for a) programs created to address income gaps, b) the fact more houses are headed by singles today than 30 years ago and c) age. The household income of a 24-year-old college grad in her first job versus the household income of her parents, combined, in their prime earning years, is not inequality. It’s just life. Finally, demographic trends aren’t market drivers. Though, we’d also point out, Millennials outnumber Boomers. Japan didn’t have a lost decade because its working-age population started declining. Those economic troubles had a wee bit more to do with Japan’s structurally unsound state-sponsored neo-feudal-mercantilist economy.
Market Wrap-Up, Thurs Oct 23 2014
Below is a market summary (as of market close Thursday, 10/23/2014):
Global Equities: MSCI World (+0.8%)
US Equities: S&P 500 (+1.2%)
UK Equities: MSCI UK (+0.2%)
Best Country: Sweden (+1.4%)
Worst Country: Japan (-1.2%)
Best Sector: Energy (+1.4%)
Worst Sector: Consumer Staples (-0.2%)
Bond Yields: 10-year US Treasurys rose .06 to 2.27%
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.