Stock and bond markets flash warning signs while IGA’s 13.9% MLP returns consistently beat benchmark.
Master Limited Partnerships have compelling valuations, high yields and improving hydrocarbon markets. Relative to other asset classes MLP are deeply oversold. The S&P 500, FANG stocks and bitcoin investments mirror the speculative behavior of the equity markets in 1998 and 1999. With rising short and long-term rates, the 36-year bull market in bonds appears to be making a secular top. Declining rates helped to fuel the global stock market and housing booms since 1981. This favorable interest rate prop is reversing. We may at a market tipping point where the asset allocation rules of the last 36 years will no longer perform as they have in the recent past. MLPs negative correlation to the market could soon prove to be a valuable safe investment hedge and one of your best income generating investments in your portfolio.
In 1998 and 1999, MLPs under performed while the NASDAQ composite and internet stocks moved upward in an epoch bubble. Following the March 2000 stock market peak, both the S&P and NASDAQ suffered historic declines. What most fail to remember is that MLPs outperformed in 2000 and 2001 while the NASDAQ and S&P 500 suffered their worst bear market since the market crash of 1929. In fact, MLPs were negatively correlated to the NASDAQ and S&P 500 in 1998 and 1999, and emerged as one of the few safe investments during the 2000-3 historic market decline.
It is also noteworthy to observe the current cyclical extremes between commodities and the S&P 500. The chart below also illustrates an extreme relative valuation of commodities prices versus the S&P 500. This chart, like the, table above, suggests that this party may end soon and MLPs should prove to be not only a hedge but an outstanding investment when this market peaks. What could be the catalyst to turn the markets? A reversal in interest rates could lead to a revaluation of financial assets.
Our fear of interest rates rising is not entirely original. Jeffrey Gundlach, the bond guru and DoubleLine CEO called a bottom in US Treasury notes yields in July 2016. He is now sounding the alarm that rates may be about to move higher. On October 24th, Gundlach tweeted “The moment of truth has arrived for secular bond bull market! Need to start rallying effective immediately or obituaries need to be written.”
October was the fifth month in a row that Income Growth Advisors Separately Managed accounts outperformed the Alerian Total Return Index, but this is a contest of least disappointing performance.
Master Limited Partnerships are still digesting the historic sector collapse of 2014-2016 when West Texas Intermediate Crude Oil peaked at $107/bl in June of 2014 and bottomed in January 2016 at $26/bl. The lower price environment has reshaped US hydrocarbon industry. The United States is now a competitive world hydrocarbon production leader along with Russia and Saudi Arabia; however, the vestiges of excessive leverage and businesses dependent on past prices and volumes is leading to continued financial and balance sheet restructuring.
In recent months we have seen distributions cuts at industry giants like Plains All American Pipeline, LP (PAA) and a surprising distribution growth rate reduction at industry leader Enterprise Products Partners, LP (EPD). All this amounts to is a fundamental right sizing of energy businesses relative to the new pricing world order. While the United States is recapturing market share at the expense of other global producers, our success comes with some financial pain. We believe that the US hydrocarbon business is shifting to a lower growth mode where Master Limited Partnerships will be less dependent the capital markets for debt and equity financing to fund growth. Rather, MLPs will be increasingly financing themselves from their own internally generated cash flows. This fundamental operating shift explains MLPs’ challenging sector performance. The chart below suggest a double bottom in the MLP sector.
Since market bottoms (like tops) are hard to call, we suggested an income averaging process of allocating monthly to this sector, rather than try to predict the precise bottom in the MLP sector. On a stock picking basis, selecting those companies effectively implementing restructuring strategies to resize and those less leveraged-faster growing MLPs are where outperformance is being generated.
MLP Selections and Our Bespoken MLP Portfolio Profiles:
Three restructuring plays we like currently are Crestwood Equity Partners, LP (CEQP), American Midstream Partners, LP (AMID) and Calumet Specialty Products Partners, LP (CLMT) which wrote about on Seeking Alpha on September 24, 2017. https://seekingalpha.com/article/4109763-calumet-specialty-products-turnaround CEQP and AMID are in our High Yield Bespoken MLP Portfolio. CLMT is in the Aggressive Bespoken MLP Portfolio.
In our High Growth Bespoken MLP Portfolio we like Antero Midstream (AM) and Noble Midstream Partners (NBLX). NBLX reported earning on October 31, 2017 and they were red hot. Noble Midstream Partners reported “EBITDA1 of $48 million, or $46 million attributable to the Partnership, an increase over the prior quarter of 36% attributable to the Partnership.” [Read-cash flow growth is growing sequentially at 36% (qt/qt) and in triple digits annually.]
Our Blue Chip Bespoken MLP Portfolio adds a new name. British Petroleum the global integrated giant came out with a new issue MLP British Petroleum Midstream Partners, LP (BPMP). Given the lousy MLP market, the reception was weak, which makes buying BPMP a good value. BPMP should offer a $1.05 distribution which at its current $18.41 price implies a yield of 5.7%. Further the incentive split structure suggests the company will enjoy solid distribution growth and a vast inventory of qualifying assets to acquire from its parent. Consequently, this will be a new addition to our Blue Chip portfolio.
MLP Yields and Returns:
MLP yields are solid and competitive. Alerian MLP Index yields 7.73% 10/31/2017. With recovering US hydrocarbon production, MLPs should generate 3-5% distribution growth and lead to 11-13% sector performance in the years ahead. If the 2000-2002 scenario plays out, a much higher return is likely. But timing when the MLP sector definitively bottoms and how other equity and debt markets will react is always imprecise. We recommend a scaled allocation and taking the steps now to start increasing your exposure to this sector.
For income and total return minded investors, we offer our MLP SMA strategy through our prime brokers US Trust/Bank America/Merrill Lynch, Interactive Brokers and Folio Institutional. Given the improving domestic energy market and compelling income prospects this is an excellent time to allocate to MLPs. MLPs offer a clear pathway to an attractive, growing and tax advantaged income stream ideal for retirement and investment diversification.
If you have any interest in discussing specifics regarding the strategies outlined in this letter, please feel free to contact us.
Tyson Halsey, CFA