|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 Daisuke Segawa and Kazumichi Shono, The Yomiuri Shimbun, 01/28/2015|
MarketMinder's View: “Though the yen’s depreciation was expected to boost exports under the government’s scenario for economic growth, it is difficult to say tactics have progressed smoothly.” The excessive trade deficit mumbo-jumbo here misses the point—plenty of vibrant economies like America’s run trade and current account deficits. Rather, the notion we think you should take from this is that the weak yen hasn’t stimulated growth. And we didn’t expect it to, because in today’s globalized economy, few if any exports are entirely domestically produced. In Japan’s case, raw materials and energy products are heavy imports for industrial Japan, and a weak yen makes those input costs higher. Additionally, the same factors hit Japanese consumers. Weak, strong, whatever—currency valuations merely create winners and losers.
|By Ron Insana, CNBC, 01/28/2015|
MarketMinder's View: The allegedly scary thing is the possibility the ECB loses money on assets it purchases, either through interest rate fluctuations or an outright sovereign default. We would suggest this is wide of the mark. For one, contrary to the assertion in this piece, the ECB plan targets longer-term bonds, which aren’t at negative yields anywhere in the eurozone. Now then, if rates do rise, it’s true the ECB could take a loss. But should they do so, it’s not like you would get a financial panic—they could simply print more money. You might yelp, “That’s inflationary!” But that’s kind of the point of the ECB’s plan anyway. Now then, we agree ECB bond buying isn’t the right medicine for the eurozone, but it isn’t for any of the reasons included here, or for any of the reasons this piece lauds US quantitative easing (QE): QE, no matter which side of the Atlantic you are on, flattens the yield curve (the spread between short-term and long-term rates, and a proxy for bank lending’s profitability). A flat yield curve has never been shown to stimulate an economy, because less profitable bank lending likely means less plentiful money. A steep yield curve, on the other hand, has long been an indicator of positive economic growth ahead.
|By Paul Ziobro, Josh Mitchell and Theo Francis, The Wall Street Journal, 01/28/2015|
MarketMinder's View: The headline would be more accurate if it read, “Strong Dollar May Squeeze Some US Firms to Some Extent.” Consider: What about input costs for US firms that might import some intermediate goods or raw materials? For them, wouldn’t a strong dollar expand profits? Oh, and we’d suggest markets are well aware of the dollar’s strength. The likelihood it derails the bull market is exceptionally low, just as it didn’t when the dollar was quite strong in the 1990s.
|By Szu Ping Chan and James Titcomb, The Telegraph, 01/28/2015|
MarketMinder's View: Greek Prime Minister Alexis Tsipras’s new government is up and running, and some suggest it is poised to take a hard-line stance against its EU/IMF/ECB creditors, as evidenced by his nominating extremely anti-austerity cabinet ministers, ending privatizations and issuing rhetoric against EU foreign policy. But we would caution against reading a lot into the first three days of Tsipras’s government. This isn’t the first Greek government to start negotiations with the troika by saying they won’t just tuck their tail between their legs. History suggests concessions and comprises between Greece and its creditors are likely eventually. For more on Greece, see our 1/27/2015 commentary, “Greek Government Theatrics and Other Reruns.”
Market Wrap-Up, Tuesday Jan 27 2015
Below is a market summary as of market close Tuesday, 1/27/2015:
Global Equities: MSCI World (-0.4%)
US Equities: S&P 500 (-1.3%)
UK Equities: MSCI UK (+0.4%)
Best Country: Japan (+2.6%)
Worst Country: United States(-1.3%)
Best Sector: Utilities (+0.8%)
Worst Sector: Information Technology (-2.6%)
Bond Yields: 10-year US Treasury yields fell 0.02 percentage point to 1.80%.
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.