The Bond Vigilantes Are Back
It’s been a rough-and-tumble week for income investors as well as the broad market.
The bond-market rout that’s bedeviled dividend stocks over the past two months is finally causing growthier fare to bleed as well.
Although inflation remains low, the latest jobs data suggests it could soon pick up.
In particular, the market keyed in on wage growth, which has been underwhelming in recent months but surprised to the upside in today’s employment report.
Average hourly earnings climbed 2.9% year over year, surpassing economists’ consensus forecast by a significant three-tenths of a percentage point.
More important, this was the single strongest number for wage growth since the Great Recession.
While economic data can be volatile from month to month, the upward trend in wage growth is unmistakable.
The fact that it’s coinciding with an increasingly tight labor market suggests that it will continue to head higher.
Rising wages are crucial to a virtuous business cycle. Higher wages boost spending, which in turn boosts demand and, ultimately, inflation.
The bond market has suddenly awakened to this possibility. The resulting selloff has pushed the yield on benchmark 10-Year U.S. Treasuries to 2.83%, or nearly 80 basis points higher than it was at the beginning of September.
That’s a remarkable repricing of risk in a very short time. Even with such a favorable economic backdrop, the bond market may be moving too far, too fast.
If yields soon hit 3.0%, then we could see bond traders back away from their reflation bets for a little while until actual economic data catches up. After all, that’s what happened in 2013.
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Enterprise Products Partners LP (NYSE: EPD) was headed back toward a two-year high, but in recent days investors knocked it down.
That’s despite the fact that EPD reported a great fourth quarter that absolutely crushed Wall Street forecasts.
Adjusted EBITDA grew 14% year over year, to $1.5 billion, powering 16% growth in distributable cash flow, to $0.56 per unit. Distribution coverage was a solid 1.3 times for the quarter.
Segment results were consistently strong across the board.
Looking ahead, EPD plans to invest about $3 billion this year in growth capital, also well above analyst expectations.
But two things came up during the analyst call that may have spooked some investors or disappointed others:
1) One analyst asked about whether the MLP structure remains optimal for EPD in light of tax reform.
Management said the MLP structure works for them as far as access to equity capital at a reasonable price is concerned.
But they did say they would continue to monitor how the market values midstream C corps vs. MLPs. However, they also noted that the prospect of conversion is not something “to be taken lightly.”
The market likes certainty, so a candid response where the company admits something that anyone would reasonably expect them to be doing probably wasn’t what it was looking for, especially given the potential tax implications of conversion for longtime unitholders.
But it sounds like conversion remains highly unlikely.
2) Another analyst asked about what their plans are for the excess cash flow they’ll be generating once they become fully self-funding on the equity side of their financing.
The market was probably looking for management to say they would restore distribution growth to former levels. But they demurred by noting it was too soon to speculate.
Let the market pout. EPD’s financial conservatism and irreplaceable asset base continue to make it a core holding for income investors. EPD remains a Buy.