In an era when financial markets continue to blackmail policymakers into keeping rates low and liquidity high and think that they are succeeding, this case study of Master-Limited Partnerships (MLP) of energy companies cannot be reiterated enough.
This sudden and punishing bear market for MLPs shows what can happen when a prevailing belief system, or narrative, falls apart. As we have commented to a number of clients, if the highest quality MLP enterprise (there’s that hint again) can fall 40%, pushing its yield up to 6% when it bottomed (hopefully) week before last, imagine what can happen to the small cap ETF—yielding only 1.4% and increasingly exposed to outrageously priced small biotech stocks—when it begins to tumble. Presently, the meme of a strong dollar benefiting small caps is dominant but that’s not going to prop them up forever.
Nor is the much vaunted concept of an equity risk premium (ERP) in a low interest rate environment likely to save the day. The idea with this is that when interest rates are very low, stock prices should be high. Yet, as you can see below, MLPs now yield 500 basis points (5%) more than 10-year treasuries and that hasn’t supported them, until very recently. [Link]
I did run into the blog of Evergreen-Gavekal before. They write good stuff. Wish I visit the blog more regularly.