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The Loud Message of Fat Yields

By Robert Rapier on December 2, 2015

As we approach the end of what is likely to go down as the worst year ever for master limited partnerships, it is worthwhile to place the current market in the context of historical MLP performance. We can get a glimpse of the bigger picture by looking at the Alerian MLP Index (AMZ), which consists primarily of large and mid-cap energy MLPs.

The AMZ is a composite of the 50 most prominent energy MLPs, capturing about 75% of the sector’s market capitalization. The index includes MLPs involved in gathering and processing, natural gas transportation, petroleum transportation, exploration and production, coal, compression services, propane, refining and shipping.  

The AMZ was launched in June 2006, but Alerian has back-tested the index by rigorously applying the index methodology to each historical rebalancing date to select and weight constituents. This shows the total returns the index would have garnered going back to 1995. The index tracking the total returns of AMZ components, including distributions, is known as AMZX.

151202mlpiiamzx

We are currently experiencing only the second major correction in 20 years. The first took place in 2007 and 2008, and dropped the index 41%. The current correction began in the third quarter of 2014 and to date has cost the AMZX 39%.

The average yield of the index going back to 1995 is 7.45%. We might infer from the following chart that when the composite AMZ yield drops below 6%, prices have possibly overheated and are at risk. Yields had dropped below 6% prior to both major corrections:

151202mlpiiamzyield

We might also infer that when the composite yield of the index is above 10%, units may be undervalued. When the yield exceeded 10% in December 1999, the next 12 months saw the AMZX rally 46%. When the yield rose above 10% in December 2008, the AMZX rose 76% over the next year. Here is a combination of the previous two graphics, showing the relationship between yield and price:

151202mlpiiamzxandyield

Note that the AMZ currently yields 8.5%, up from 6% six months ago. We are approaching yields that have historically preceded a period of outperformance. Should year-end tax selling put further downward pressure on MLP units and thus bump yields up even more, history would suggest it’s about time to buy into the sector.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

 

 


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R.I.P Bull Market—Here’s How To Protect Your Wealth

I hope you’ve enjoyed the phenomenal bull market of the past eight years…

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And that leaves you with two options…

Do nothing and suffer the agony of watching the profits you’ve accumulated over the years evaporate right before your eyes…

Or reposition your portfolio and invest in companies which prosper as inflation rises and interest rates soar.

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