Nov 15th, 2012
MLP Market Post
MLP Cliff Dive Update
Last week’s 2.6% decline by the Alerian MLP Index was just the under card, the main event was this week, as MLPs and other high yield securities have gone from in favor to out of favor in the blink of an eye. MLPs have been out of favor all this year, it seems like the exact moment when everyone was touting high dividend strategies late 2011 was the right time to implement your “yield-off” strategy. This week, the MLP Index is down 5.7% so far, bringing the total drop for the MLP Index (including distributions) to 8.8% in 7 trading days, as shown in the chart below. Early returns indicate that MLPs may have been a little overvalued heading into the election…
The MLP drop has been getting wide coverage, with many attributing the underperformance to the pending fiscal cliff. But the truth is it is probably a combination of things. We’ve had around $800mm in MLP equity come to market this week with MWE, SEP and NGLS all launching follow ons. We’ve had 9 MLPs IPOs since July, with several more on file. When more equity paper meets less demand (i.e. fund flows out of the sector), this type of price action tends to happen. Also, Obama’s election, although by no means a surprise, is viewed as a marginal negative for the energy industry as a whole. It is viewed as a clear negative on tax issues, but not many of them specifically targeting MLPs. Also, distributions were just paid, so that quarterly weakness that results from people selling post-distribution is factoring in here. Also, there is tax selling. In very few prior years have there been such wide ranges between the winners and losers in the MLP space. Before this week, chances are MLP investors had some MLP gains and some MLP losses. Some investors are probably selling to match up those gains with losses.
My point is, its not just the tax stuff. On the flip side, it doesn’t seem like selling is focused around the fundamentals of the MLPs. Maybe there is some element of selling as a result of weak earnings or fears over a decline in energy activity as a result of a weak economy (it was certainly fundamental reasons that brought down OXF and HCLP in recent weeks). For the most part, however, we are seeing (hopefully) transient non-fundamental factors overwhelm the still very small MLP sector. For core MLPs that have their financial house in order (i.e. don’t have to issue a bunch of equity), now would seem like a good opportunity to own more of them for less than a few weeks ago. When MLPs get to their peaks and VIX goes down, as happened from late June through October, its always a good idea to take some money off the table and hold back a little cash for weeks like this. But, as I’ve mentioned before, don’t buy them on margin. I have the scars to prove its not a good idea.
Last week, I wrote about how rare it was for the Alerian MLP Index to drop 2% in a given week. Below is the chart from that post, updated with this week’s decline. This week, we’ve see 2% decline on 2 separate days, so things have clearly deteriorated. And yet, MLPs are issuing equity into the face of this drop, which certainly doesn’t help.
As you can probably guess, it is rarer to see MLPs drop 5% in a week than 2%. So far, including this week, it has happened 16 times in 17 years, including 7 times in late 2008 / early 2009. 5% decline days have happened with more frequency in recent years. They usually occur around an event. In 2001, it was 9/11. In 2010, it was the flash crash and a serious MLP taxation rumor / scare in May. In 2011, it was the debt ceiling charade that played out in August. This year’s earlier 5% decline happened in May, can’t remember what specific issue was at hand. This week’s 5%+ decline will be remembered as caused by the election and expectation of congressional bottlenecks leading to a spike in tax rates for investors.
What was interesting in looking at those 16 times when the index dropped 5% in a week, 8 of those times, the 5% decline week was preceded by a 2%+ decline week, as we had last week. For MLP optimists, that pattern might suggest that a typical MLP correction lasts around 2 weeks, accelerating the second week, before recovering. The point for me is that what we are seeing is “precedented”, and although it has happened only 8 weeks out of 878 possible weeks, it has happened before, and it will probably happen again to MLPs. If you can’t handle the occasional downdraft around some event that is usually not related to the fundamentals of the MLPs themselves, then MLPs may not be for you.
But because good yield is hard to find, we’ve got more people than ever buying MLPs, and many of them may not have gone through such a downdraft before, at least not in these magical MLPs.
Since you asked for it, here is how the MLP Index has historically done over the next twelve weeks after the 8 prior times it has dropped 2%+ one week and 5%+ the next week. Remember past performance is not indicative of future results. Good news is that MLPs have done well on average in the weeks that follow such a decline. The bad news is that results are mixed in terms of returning to values seen before the drop.