|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 Carl Richards, The New York Times, 07/23/2014|
MarketMinder's View: There is some wonderfully sensible commentary here, though the article has a couple of warts too. Differentiating between knowledge and behavior is crucial for individual investors. All too often, investors know what the right answer is (need growth, buy stocks; don’t sell deep in a bear market; don’t concentrate in employer stock/high performing stocks/any stock) but they do it anyway based on a rationalization (“it’s different this time,” etc.). The knowledge doesn’t influence the actions, and the actions matter most. That said, there is a balance problem here. The article touts the merits of attaining knowledge—the past—and discounts a forward-looking view as risky. Yet the entire purpose of knowing the past is to help you put the present and the future in context. Finally, financial literacy is important (we are passionate about this at MarketMinder)—but there is a stark difference between being literate and being an expert, just as the fact someone can write a grammatically correct sentence doesn’t make him or her Hemingway.
|By Naftali Bendavid and Matthew Dalton, The Wall Street Journal, 07/23/2014|
MarketMinder's View: To be fair, the details won’t be released until Thursday. But to be judgy, it appears based on existing reports the EU is again going to avoid imposing material sanctions on Russia, targeting mostly individuals and very specific organizations, rather than sector-wide sanctions. What’s more, it appears the notion of ceasing arms trade with Russia is also failing. If they can’t agree to stop selling weaponry to Russia after last week’s downing of a civilian aircraft using Russian technology, we kind of think it might be a wee bit of a stretch to expect harsh sanctions overall.
|By Jeremy Warner, The Telegraph, 07/23/2014|
MarketMinder's View: So another big organization is out with their market take, and it’s another one of those investors-are-too-complacent, low-volatility-will-end-badly, too-long-since-a-correction, markets-are-frothy-blame-central-bankers(!) rants. But is it really bubbly that global stocks are up ~40% in the last two years? Prior to this cycle, based on S&P 500 data since 1926, bull market average annualized returns are roughly 21%, so it wouldn’t seem like it. Why are markets up so much? Earnings and revenues are up! A healthy private sector still isn’t fully appreciated by the skeptical public, as illustrated by this piece. Also, two of the three risks are dubious: a rate hike (no history of regularly causing downturns) and the wiggling of other central bank rates. The third risk, the success of macroprudential regulation in deflating bubbles is real, but it is misperceived here: The issue, in our view, is not whether the Fed can successfully deflate a bubble. It’s whether they cause collateral damage trying—or deflate a nonexistent bubble. Finally, a simple correction: The 2007-2009 crisis began following corrections in 2006 and 2007. It wasn’t placid right before the storm, nor were investors complacent.
|By Todd Buell, The Wall Street Journal, 07/23/2014|
MarketMinder's View: This January, Lithuania will become the 19th nation to use the common currency. For those of you scoring at home, the current 18 are: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain. Also interesting is the new voting rotation for the 19 national central bank chiefs that will take effect in 2015: The larger nations (Germany, France, Italy, Spain and the Netherlands) will share four votes, with the smaller 14 countries splitting 11. That means one major nation will sit out every five months, a factor potentially ruffling some feathers occasionally.
Market Wrap-Up, Tues July 22 2014
Below is a market summary (as of market close Tuesday, 07/22/2014):
Global Equities: MSCI World (+0.6%)
US Equities: S&P 500 (+0.5%)
UK Equities: MSCI UK (+0.9%)
Best Country: Italy (+1.8%)
Worst Country: New Zealand (-0.2%)
Best Sector: Energy (+1.0%)
Worst Sector: Consumer Staples (+0.2%)
Bond Yields: 10-year US Treasurys fell by .01 to 2.46%
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.