MLP Quarterly Monitor : Dancing on the Edge of the Yield Bubble?
Credit indices have rallied to set new highs. Equity indices are nearing all-time highs. The AMZ has also just hit new highs. The macro backdrop is mixed. The S&P growth rate in earnings is decelerating with some calling for a decline in earnings in 2013. On the other hand, we estimate MLP distribution growth will modestly accelerate in 2013 driven by the large ramp in the sector's capital spending in 2012. The Fed has implemented QE3 with the intent of keeping rates low well into 2015. Fat tail risks (think fiscal cliff, Europe, a China hard landing, etc.) persist. As we will discuss in the valuation section of this report, despite hitting new highs in the AMZ, valuation is not stretched. This cannot be said for a wide swath of the credit market. Equity metrics are more mixed. As we will see in the performance section of the Monitor, the AMZ outperformed both equities and credit for the quarter. We think the answer to the question “Are we there yet?” is that credit and equities are closer than MLPs.
Eoin Treacy's view By supporting government and mortgage bond markets central banks have suppressed yields to previously unimaginably low levels. This has forced fixed income investors to migrate down the ratings ladder in order to capture yield. The result is that spreads have compressed across and credit sector with many unwinding the majority of the expansion posted during the credit crisis.
Spreads from BB to AA continue to compress in a consistent manner and breaks in their progressions of lower rally highs would be required to question potential for an additional tightening. Over the medium-term, lower rated credit represents one of the sectors most likely to experience selling pressure when central banks begin to wind down quantitative easing. Logically, when the provision of liquidity eventually becomes less of a certainty, the need to price risk according to the individual merits of companies will rise commensurately.
The MLP sector represents an interesting proposition because of its relationship with energy infrastructure and the continued boom in US unconventional oil and gas production. The JPMorgan Alerian MLP ETF continues to hold a progression of higher reaction lows and a sustained move below $46 would be required to question medium-term scope for continued higher to lateral ranging. (Also see Comment of the Day on May 2nd for a piece on MLP tax liability for foreign investors)