|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 Staff, The Wall Street Journal, 09/17/2014|
MarketMinder's View: Don’t you feel like the title of this article should have an exclamation point or two after it? “Read the Full Text of the Fed’s Statement!!!” Just kidding, here’s one of the more dull things you’ll ever read (boldface ours): “The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.” Zzzzzzzzzzzzzzz. [Drools on keyboard.] And yet whether the two bolded words would be in this statement has led to a whole lot of misplaced handwringing this week. Talk is cheap, especially fedspeak. Which is basically marketing spin. For more, see our 09/16/2014 commentary, “Words, Words, Words.” About the only meaningful part of this Fed statement? That they will slow quantitative easing bond buying again, to a pace of $15 billion in October. Which is no surprise.
|By Eduardo Porter, The New York Times, 09/17/2014|
MarketMinder's View: A few things about this. One, globalization is not synonymous with the decline of US manufacturing. In fact, many US manufactured goods source parts from other places around the world, which is what globalization is: an interconnected global economy where nations specialize in what they do best and trade flows move freely. It would be to our great detriment if globalization “retreated.” Second, there is no decline in US manufacturing. US manufacturing output has steadily risen despite fewer workers in the industry. Why? Because technological advance is the real key that’s destroyed American manufacturing jobs. See it for yourself in this chart we created on the St. Louis Federal Reserve’s wonderful website comparing US industrial production and US manufacturing employment as a share of total payrolls. We manufacture more with fewer workers, and that’s good for the economy, not bad. To paraphrase Milton Friedman, we could go hire a bunch of folks to dig ditches with spoons. Employment would skyrocket. But is this a good use of scarce capital? In case you want even more on this, maybe read Todd Bliman’s 11/09/2010 column, “The Ever-Evolving Economic Engine” or this 04/28/2014 article by Businessweek’s Charles Kenny, “Why Factory Jobs Are Shrinking Everywhere.” It’s easy to blame China and foreigners, riling up the xenophobia, but the facts don’t comport to that theory very neatly.
|By Matthew Yglesias, Vox, 09/17/2014|
MarketMinder's View: So the claim here is Obama, by not nominating two more “unemployment fighters” to the FOMC, has doomed America to many to years of unemployment because the Fed hasn’t been as accommodative as—wait for it—the UK(!). This is just plain ol’ backwards. First, the linkage between monetary policy and employment is not nearly this direct. Second, quantitative easing—the policy launched with the intent of boosting hiring—wrongheadedly flattened the yield curve, a disincentive for banks to lend because it meant the spread between banks’ funding costs and interest revenues were lower (less profitable lending). Bank lending is the transmission mechanism for the Fed’s policy to reach the real economy, so a lower yield spread will work against the Fed’s intent to “stimulate” growth, which begets hiring. But the big miss here is the commentary involving the UK. The UK recovery was back and forth until the Bank of England ended quantitative easing. They stopped buying bonds long before the US started winding down its program, and their economy accelerated! The Fed actions cited here as “unwisely tightening monetary policy” are the very actions that caused the UK economy to perk!
|By Michael Calia, The Wall Street Journal, 09/17/2014|
MarketMinder's View: We guess the desired reaction to “For Now” is something like, “Oooooooooooooooooooo! A potential downgrade!” But when you read the rationale, it’s a little more like, *yawn*. It’s all predicated on the long-run costs of social security, which is an entitlement program that could be altered at any point, like it has been historically. Second, it cites the dollar’s status as a reserve currency as the factor allowing the US to “carry more debt than other nations.” Yet Japan doesn’t have the world’s reserve currency and it does have more than twice the US’s debt load as a percent of GDP. The pound is also not the dominant reserve currency, and yet it has similar debt levels and low rates. See, Moody’s has it backwards. The simple truth is the vast amount of outstanding US Treasury securities is what allows the dollar to be the biggest player in the forex reserve market. Anyway, it’s a ratings agency—which aren’t exactly known for displaying oodles of forecasting prowess.
Market Wrap-Up, Wed Sept 17 2014
Below is a market summary (as of market close Wednesday, 09/17/2014):
Global Equities: MSCI World (+0.2%)
US Equities: S&P 500 (+0.1%)
UK Equities: MSCI UK (+0.5%)
Best Country: Denmark (+1.7%)
Worst Country: New Zealand (-1.4%)
Best Sector: Materials (+0.4%)
Worst Sector: Energy and Consumer Staples (-0.2%)
Bond Yields: 10-year US Treasurys rose .06 to 2.63%
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.