May Signals a Long, Hot Summer for MLPs

 |  Includes: BP, EPP
by: Avi Morris

May was the worst month for MLPs since November 2008 (and one of its worst months in history). The Alerian MLP Index dropped from 311 to 292 while volatility shot up. Traditionally MLPs are low beta securities with only modest variations are the trend line. However volatility was substantial in the financial crisis of 2008. But this year volatility was modest until May. In May the index ranged between 270 (ignoring 260 which may not have been a correct number on Flash Thursday) and its yearly high of 319. The index gained or lost 2+% on 9 days in May. The index is up 2% YTD, not a bad showing for 2010. But it could be entering turbulent waters.

MLPs continue moving energy around the US and investing in building more miles of pipelines. For example Enbridge Partners (NYSE:EEP) opened the first phase of the Alberta Clipper on April 1, a very big expansion move. There were more announcements by MLPs on securing financing. However, the oil spill in the Gulf may change investment attitudes about energy issues for nervousness investors. MLPs are not directly involved in the mess caused by BP (NYSE:BP), but it adds worries about new regulations for all energy companies. Markets don't like uncertainty.

US financial markets were shaken by news about European debt problems. The immediate attention was on Greece and its need to pay off debts due on May 19. eurozone countries created a trillion dollar bailout fund which allowed Greece to pay debts. However difficulties in European financial markets are not over. Many countries (especially in the Mediterranean region) have not made sufficient cuts to balance budgets, needed to reduce their need for additional borrowings.

Investors worldwide sold securities motivated by "risk averse" thinking. Treasuries were back in demand similar to the financial meltdown 18 months ago but less intense. Demand for Treasuries soared causing the yield on the 10-year Treasury bond to plunge below 3.2% before closing May at 3.30%. These yields were not seen in over a year when frightened money pushed yields down to 2.1%. The VIX, volatility index, had fallen to 16 before jumping to the 40s in May and then settling back to 30 by month's end. Extreme fears eased in the last week, buyers bought MLPs and junk bond funds to lock up high yields.

MLPs should continue to perform well, although they would all like to see a robust economic recovery and that's uncertain. Calm financial markets will needed for further advances in MLP unit prices. That may not be. The MLP index yields 7.35% up from the recent low at 6¾%. The yield spread over the 10-Year Treasury yield is 400 basis points, up from 300 points a month ago. Earlier optimism about MLPs has been reduced. European debt problems are not expected to go away anytime soon. After the performance in May, this could be the start of a long, hot summer for MLPs (along with other high yielders).