|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 Aaron Back, The Wall Street Journal, 03/05/2015|
MarketMinder's View: While some are calling China’s projected RMB 1.4 trillion drop in government borrowing a liquidity-zapping “fiscal cliff,” as this piece shows, reality is more benign. This isn’t a huge planned pullback in public investment or liquidity squeeze. It’s an attempt to shift from public financing to private, where officials believe lending decisions will be more judicious and investment more productive. Time will tell whether they’re right—execution matters—but they appear to have a system in place to continue financing infrastructure and development. And if it doesn’t work, leaders there have a long track record of saying one thing and doing another, as needed, to shore up growth and job creation. We rather doubt China will really find itself “stuck in the fiscal mud.”
|By Jesse Eisinger, The New York Times, 03/05/2015|
MarketMinder's View: Look, we don’t think Dodd-Frank was some magical bank safety-enhancing, crisis-ending panacea either. But the metrics used here to evaluate it are just bizarre. Bank profits as a negative? Last we checked, profits are a sign of health, and banks have retained most of those earnings to shore up capital levels. Supposedly high financial services fees as evidence of a lack of competition? We have a hard time seeing that one in an industry with tens of millions of customers. Bank dependence on short-term funding? That assumes retail depositors—all of us normal folks—don’t flee when things look dicey. Take a peek at Greece if you need proof that assumption is incorrect. Overall, we don’t see much (if any) evidence the financial industry is merely a “money-extraction machine, enriching itself while endangering society as a whole.” If that were the case, why would capital be flowing freely from banks to businesses? Banks are investing in the real economy, folks.
|By Jacob Pramuk, CNBC, 03/05/2015|
MarketMinder's View: Well, we respectfully disagree with the thesis that a bubble limited to select private firms—not publicly traded stocks—is actually a bubble. Simply, bubbles are caused by widespread euphoric sentiment overlooking negative fundamentals. The number of investors diving into these private firms is extremely small, and even if you presume their valuations are wacky (we have no way to verify that), that isn’t a sign of widespread euphoria. Folks, the tech sector was 30% of the S&P 500 when the tech bubble was at its zenith. Now, these private firms might be a fad, like small “momentum stocks” were in early 2014. But global economic and market fundamentals today appear overall better than sentiment appreciates, which does not a bubble make. Finally, we are not 100% convinced the blog post that inspired this article wasn’t ironic.
|By John Authers, Financial Times, 03/05/2015|
MarketMinder's View: This claims to prove fees matter more than asset allocation (the mix of stocks, bonds, cash and other assets you use), but it does no such thing, because the method of proving the point herein is totally flawed. For one, it’s a simple backtest of various portfolios using results from 1973 – 2013. That might seem sufficient to draw major conclusions, but you should really use Monte Carlo analyses for this, because the past won’t predict the future order in which returns occur, perhaps throwing the entire basis for drawing conclusions off. E.g., would any of this be the same in 2009? Or 1999? Answer: No. Additionally, the evidence of the influence of fees is demonstrated by simply subtracting returns (1.25% - 2.25%) from very same strategies outlined. Which is a self-reinforcing feedback loop. You cannot calculate the impact of fees this way and prove anything other than the fact you can do basic mathematics. It also does not at all address how you arrived at the allocation in the first place, which is crucial because no matter what you pay, your allocation darn well better match your goals. Said differently, if two identical bond portfolios had different fees, that would be the deciding factor. But it wouldn’t say anything about whether or what percentage you should put in bonds in the first place. Finally, these are all inflation-adjusted returns and the inflation adjustment used is neither explained nor described. This is really just a bizarre comparison of various strategies, not a study showing fees matter more than asset allocation.
Market Wrap-Up, Wednesday Mar 4 2015
Below is a market summary as of market close Wednesday, 3/4/2015:
Global Equities: MSCI World (-0.4%)
US Equities: S&P 500 (-0.4%)
UK Equities: MSCI UK (-0.3%)
Best Country: Belgium (+0.2%)
Worst Country: Portugal (-3.4%)
Best Sector: Health Care (+0.2%)
Worst Sector: Materials (-0.9%)
Bond Yields: 10-year US Treasury yieldswere unchanged at 2.12%.
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.