Author Archives: Scalper1

Is This The Worst Time For MLP ETF Investing?

The double whammy of the recent crash in crude oil price below $40 and the Fed’s hawkish stance on interest rate hike are causing mayhem in the master limited partnership (MLPs) business. MLPs are involved in the business of transportation and storage of oil and gas, and they are suffering even more than the oil producers from the downturn in the market. MLPs primarily benefit from an uptick in oil production. However, U.S. oil producers are resorting to a cutback in oil production in response to falling prices. Oil drilling companies have idled over half their rigs from last month. The latest data from Baker Hughes Inc. (NYSE: BHI ) revealed that rigs engaged in the exploration and production of oil and gas totaled 767 for the week ended November 13, 2015, a decline of 4 from the prior week’s count and the lowest level seen since April 2002. The nationwide rig count is still less than half the prior-year level of 1,928. Despite a marginal rise to 574 last week, the oil rig count continues to be on the low end of the five-year range and is significantly below the previous year’s level of 1,578. International Energy Agency (EIA) has also reduced U.S. production outlook for 2016 by 1% to 8.77 million barrels per day. Some might think that the oil price is hitting its bottom but in reality it might head further south. This is because EIA has indicated that the global supply glut could get even worse as global stockpiles have reached the record level of 3 billion barrels owing to abundant supply from the OPEC countries as well as Iraq and Russia. Secondly, a strengthening U.S. dollar supported by the possibility of an interest rate hike weakens the demand scenario for greenback-priced commodities such as crude. A rising interest rate environment would also adversely impact the performance of MLPs for a number of reasons. Firstly, higher interest rates lower the appeal for high-yielding stocks such as MLPs, which have historically offered around 5% in yields and hence attracted investors’ attention due to ultra-low interest rates. Secondly, MLPs heavily depend on external financing to run their operations as they distribute most of their income as dividends. As a result, a rise in interest rates would increase their financing costs, which in turn would diminish their ability to keep distribution payments at the existing level. The adverse developments in the oil and gas sector and the threat of a looming interest rate hike are heavily weighing on MLP stocks and ETFs and indicate the worst may not be over yet. Below we highlight three MLP-based ETFs that have witnessed double-digit fall so far this year and may continue to experience a downspin in the near future as well. Alerian MLP ETF (NYSEARCA: AMLP ) This is the most popular MLP ETF with AUM of $7.3 billion. It tracks the Alerian MLP Infrastructure Index, measuring the performance of 25 energy infrastructure MLPs. The fund’s top three holdings include Enterprise Products Partners LP (NYSE: EPD ), Magellan Midstream Partners LP (NYSE: MMP ) and Energy Transfer Partners LP (NYSE: ETP ), together accounting for 25.4% of assets. The ETF trades in a solid volume of 7.1 million shares per day and is very expensive with 5.43% in expense ratio. It offers a robust dividend yield of 9.3% and has lost around 27% in the year-to-date timeframe (as of November 18, 2015). Credit Suisse X-Links Cushing MLP Infrastructure ETN (NYSEARCA: MLPN ) MLPN follows the Cushing 30 MLP Index, measuring the performance of 30 mid-stream stocks in North America. The note is well distributed with its top 10 holdings comprising around 35% of the assets. It has an AUM of $505 million and exchanges roughly 192,000 shares in hand per day. MLPN charges 85 bps in annual fees and has a dividend yield of 6.8%. The note tumbled nearly 34% so far this year. iPath S&P MLP ETN (NYSEARCA: IMLP ) IMLP tracks the S&P MLP Index measuring the performance of MLP stocks that are classified in the GICS Energy Sector and GICS Gas Utilities Industry. Enterprise Products Partners, Energy Transfer Equity LP (NYSE: ETE ) and Energy Transfer Partners are the top three holdings in the fund with a combined exposure of nearly 35%. The product has amassed around $413 million in assets and trades in a moderate volume of roughly 97,000 shares per day. It charges 80 bps in investor fees and offers a dividend yield of 7%. IMLP shed 31.6% in the year-to-date timeframe. Original post .

Expected Returns For The Next Ten Years

According to Jack Bogle and Michael Nolan, U.S. stocks are projected to gain about 6% per year over the next decade. Bonds are projected to earn about 3%. These return projections are significantly lower than the long-term averages of 9% and 4.5%, respectively. For the bond market, future returns are expressed as the current yield to maturity. The yield to maturity on 10-year Treasuries is 2.4%, which Bogle and Nolan round up to 3%. (This could be justified by the addition of higher-yielding bonds.) Since today’s 10-year Treasury yield is 2.3%, that estimate looks reasonable. Stock market returns have three components: the market’s current dividend yield the estimated annualized growth in corporate earnings the expected change in the market’s price/earnings ratio Stock Returns = dividend yield + earnings growth +/- (change in P/E ratio) With the stock market today yielding about 2% and historical earnings growth of 4.7%, Bogle/Nolan arrive at a preliminary estimate of about 7% per year, which they reduce to 6% by figuring that today’s P/E ratio will end up ten years from now at its long-term average of 17.8. Enterprise Returns and Speculative Returns Bogle took inspiration from John Maynard Keynes. Keynes believed that the best economic models are as simple as possible, with components and results that are clearly understood. For example, stock returns could be decomposed into two sources: enterprise returns, which are the returns that came from the growth (or shrinkage) of the intrinsic business, and speculative returns, which come from changes in investor psychology. Bogle uses Keynes’ framework to construct his model. Dividend yield plus earnings growth measures the stock market’s enterprise returns. The last Bogle term – the change in the P/E ratio – equates to Keynes’ concept of speculation. What’s An Investor To Do? First, expect lower than usual returns from both stocks and bonds. There’s no way for bonds to achieve high returns, given a starting yield of 2.4%. As usual, stocks offer less certainty. It’s possible that continued low inflation justifies a market P/E ratio of 25 or higher, leading to annualized stock-market gains that approach 10%. But it is also very easy to envision scenarios that fall short of Bogle’s estimate. The 6% estimate is not overly cautious. Second, inflation-adjusted returns look a little less onerous. Bogle’s models don’t take into account the effects of inflation, but today’s bond yields implicitly forecast low future inflation. If that proves true, bonds could eke out a modest real gain. Stocks would of course fare even better. A 6% nominal gain with 2% inflation means a 4% real return, which is respectable if not spectacular by historic standards and flat-out terrific compared with the paltry yields now paid by Treasury Inflation-Protected Securities. Third, the relationship between stocks and bonds looks normal. The historic return premium offered by stocks over bonds has been 4.6%. That would suggest a modest relative advantage for bonds. On the other hand, because bond yields are so depressed today, the ratio of stock-to-bond returns is not particularly low. Bogle and Nolan find no relationship between forecast equity premiums and future stock returns. Investors have to make some important decisions. If they keep their asset allocations as they are, they will probably end up with smaller account balances than they had hoped for in ten years. Bogle and Nolan do not interpret their findings as suggesting that investors should change their asset allocations. If lower account values are not acceptable, investors can either take more risk, or increase their savings rate to make up the expected shortfall. Neither of these is an ideal solution. Taking more risk will not guarantee a better outcome in ten years. And many investors simply can’t increase their savings rate due to already-stretched finances. But it’s important to face up to the fact that the expected returns over the next ten years are going to be lower than usual. Ignoring this warning and hoping for the best is an option, but not a very practical one.