MLPs Enter Challenging Week

by: Avi Morris

Last week was a brutal week for stock markets around the world, not seen since the financial meltdown. The sell-off was tough for tech stocks and especially difficult for high yield sectors. Junk bond funds typically sold off 5-10%. That would be a bad week for any stock but particularly bad for junk bonds, where a 10% move is considered extremely large.

MLPs also had one of their worst weeks in history. The Alerian MLP Index dropped 25 (8%) to 286, despite a rebound of 4.69 on Friday (when other stocks continued declining). On disastrous Thursday, the index plunged almost 15 (probably its worst single day loss in its 15 history). Part of the weekly decline was attributable to ex-distributions, but that influence was limited. The annualized rate for distributions for the index is 21.55. One fourth is 5+, a small fraction of the total decline. The decline has brought the index 10% below its recent highs. For the MLP bulls, the Friday close pulled the index back into the black YTD (by 1).

I wrote this Sunday night. European leaders had just stitched together a €500 billion bailout package with another €100B additional funds available (almost US$1 trillion total) to save the €, whatever it takes. But that is not final. Countries receiving bailout money will have to agree to austerity measures (reduced entitlement payments) which are not being accepted by the populations, shown by Greek riots last week. Germany is the largest source of financing and it is demanding budget cutbacks. The fundamental problem is troubled European countries have high levels of debt and they are trying to solve liquidity problems without much growth.

Global financial markets affect MLPs even though their investments are largely in the US. Recently, risk aversion has become a major driver in thinking by global investors. The VIX, volatility index, in just the last 3 trading days, has doubled off 20, taking it back to elevated levels during the financial meltdown. Gold has been on the rise in recent weeks bringing it near last year's record of 1200+. Treasuries had a huge rally in the last month causing its yield to plunge from 4% to around 3.4%.

Frightened investors switching investments from high yield sectors to so called safe haven investments (US Treasuries & gold) have been responsible for the sell-off in high yield sectors, like MLPs. 2 weeks ago US markets had a weak week and last week was a memorable week. This week is shaping up as highly uncertain. The gut reaction to defend the € with a bailout package is favorable. Asian markets are generally higher and US futures are in rally mode, typically up over 2%. Treasuries are plunging (taking the yield on the 10-year Treasury up 15 basis points to 3.55%). Oil is up 1½ (after its worst week since the collapse from the $147 record high) while gold has a mild decline, expected moves when markets rally. However, volatility should remain high which is worrisome for high yield instruments like MLPs. MLPs have another problem lurking in the background. The decline of the index happened after the oil spill in the Gulf. MLPs should have little if any exposure to spill problems, but this enormous disaster has the potential for Congress to meddle which could hurt all energy companies. MLPs have a lot of challenges next week. With volatility so high, caution would be exercised until markets settle down.

Disclosure: None