Acrophobia: MLPs at All-Time Highs Again

Hinds Howard  |

At this location each week, look for my weekly thoughts on MLPs.  This week’s initial column will focus on where the Alerian MLP Index is currently trading relative to its historical levels after 3 straight years of substantial outperforming the S&P 500.  In future columns, I’ll build on that post to get into some of the minutia of the MLP sector and the deals that occur within the sector.  For a general review of the language used in the sector, please visit our MLP glossary.

MLPs are gaining more press and acceptance by mainstream investors each day. If you are just looking into the sector, let me start with a map, like the kind you find in a mall that tells you where in the mall you are.

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At this point, after 31 trading days (through 2/15), 12% of the year is in the books.  MLPs have been underwhelming so far compared to the S&P 500 (up 6.8% year to date), but are off to a solid start nonetheless with 4.9% total returns.

In the chart below, I show what the MLP Index has done from the beginning of the year through this date each of the last 5 years.  As shown in the chart, not much usually happens in the first 31 trading days of the year, but out of the last 5 years, 2012 ranks third in price performance year to date at 3.5%.

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The next chart highlights the rest of each of the above years.  As shown, the first 31 trading days are not a very good indicator for what the rest of the year will look like.  Last year, MLP tax regulation gossip and broad stock market volatility caused volatility for MLPs, but the Index finished higher on the year.  Expect to see MLPs correct at some point this year, perhaps in conjunction with a major macro event.

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So, MLPs have had a solid start as a group (although there is a growing dichotomy among winners and losers, good for active managers like me) and are sitting at all-time highs.  In 2012 to date, the MLP Index has closed at all-time highs 6 times, and 12 times for the total return version of the index (including the distributions).  At the current rate, the MLP Index are on pace for 50 closes at new all-time highs this year (100 for the total return version of the index).  Each of those would be close to the record for all-time high days in a single year.  The chart below shows the number of days in each of the last 16 years that the MLP Index closed at all-time highs.

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If history is a guide, a fear of such heights is unwarranted if it’s just the all-time highs you are concerned with.  For an emerging set of companies like MLPs, all-time highs are routine as the sector grows in investor base, trading volumes and general mainstream acceptance. REITs were on a similar trajectory when that asset class (helped by declining interest rates, like MLPs) expanded a decade ago and became a mainstream allocation in portfolios of retail and institutional investors.

Also of note, the all-time low MLP yield of 5.4% has not been reached since that record was set in July 2007.  The MLP Index is currently trading at 6.0% yield, and around 400 basis points higher than the yield on 10-year treasuries. Back in 2007 when MLPs hit that all-time low yield, 10-year treasuries were yielding more than 5%, and the yield spread of MLPs to the 10-year was 42 basis points, or 10 times less than it is today.  So, while MLPs are not cheap right now, they have been more expensive in the past.

I personally feel MLPs should be entered with caution at these levels and only with particular attention paid to what types of assets you are buying with an MLP and where those assets are located, because those things matter more than ever before, given the massive multiple of oil to natural gas and NGLs to natural gas.  But what I feel shouldn’t matter, because this column is not meant to be investment advice in any way.

Disclosure: The information in this article is not meant to be financial advice, we are not your financial advisor and I am posting my comments for informational purposes only.

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