Master limited partnerships have been the worst performing sector this year. Of the ten SPDR sectors, only one is negative year-to-date, and that is energy, which has slid 8% this year. The Alerian MLP Index (AMZ) has more than doubled that decline, down 17% year-to-date. MLP money managers have remained remarkably bullish throughout this period, repeatedly brushing off the weak performance as merely being a market that is behaving irrationally while telling investors that it won’t be long before the market stabilizes. They remind prospective investors that the fundamentals paint a much different picture than the stock price performance suggests. Looking at the chart of the AMZ index tells us these managers have been dead-wrong all year. MLPs have time and time again failed to sustain any meaningful momentum. Every time there has been a glimmer of hope that the AMZ was setting up to break out of the prevailing downtrend, sellers have stepped in to ensure investors were going to have to sit through more pain. And again, MLP money managers tell the same story, that fundamentals are strong and that we are on the brink of a great recovery in the stock prices of MLPs.
I am writing today to tell you that the above is good news if you are considering an investment in this sector. As much as it feels like a lie, the story MLP managers have been telling is far from one. Fundamentally, there is a scarcity of reasons why MLPs are performing so poorly in the market. Rather than sound like a broken record listing all the fundamental reasons MLPs should be moving up, I want to talk about some different reasons why investing in MLPs right now is a compelling opportunity.
One of my favorite investor types is the contrarian investor. Contrarian investors look for opportunities that most other investors would not even consider. They look to invest in securities and sectors against their prevailing sentiment and trend. Simply, they believe that herd mentality often results in securities that get mispriced, presenting an opportunity for outsized gains when the dust settles. For example, one sector that has been under pressure this year is retail, particularly those companies operating in malls. Several mall-focused retailers are facing an existential threat from the likes of Amazon and Walmart, and indeed, there have been several bankruptcies over the last few years. A contrarian investor may look to purchase a high-quality retail stock that, due to herd mentality, was the baby thrown out with the bathwater. Now that there are signs in the market that Amazon is not going to be putting everyone out of business, many retail stocks have bounced back violently, and it is the contrarian that is reaping the rewards.
MLP stock prices, as defined by the AMZ index, have performed far worse than retail, as defined by the SPDR Retail ETF (XRT). However, there certainly has not been any midstream MLP bankruptcies this year, and there certainly is not any talk of that as even a possibility. MLPs are performing quite well as companies, and management teams have remained very optimistic. In fact, management teams have frequently expressed frustration and confusion over how their stocks are trading. In contrast to the retail example, there have been several retailers that have expressed doubt over their ability to continue as a going concern (I am looking at you, Sears). My point here is that MLPs are not facing any major operational or existential threats, yet they trade as if they are all going to zero. MLPs fit the bill as a contrarian opportunity that are mispriced in the wake of relentless, yet severely misguided, negative sentiment. Sentiment, however, is starting to shift.
There is growing reason to believe that getting into MLPs sooner rather than later should be a strong consideration for any investor. Signs that sentiment is shifting are starting to appear. Below are some recent headlines that show people are starting to pay attention to the compelling value MLPs are currently offering.
On top of this, we have seen private equity buying MLP managers. For instance, Blackstone bought Harvest Fund Advisors, the largest MLP manager around. It follows that Blackstone is expecting positive fund flows into MLPs.
Another incentive to move into MLPs is an expected rebound as tax loss selling abates. Over the past five years, the Alerian MLP index has managed considerable gains from mid-December to year end. Further, in three out the last five years, MLPs have had strong Januaries per the screenshot below. There is a narrative taking hold that
new money will flow into MLPs in 2018, and the first-derivate action to that trade is to get in ahead of the new year and take advantage of the weakness caused by tax-loss selling.
MLPs are yielding a fully covered 8% yield, they are performing strongly on the ground with improving fundamentals, they still trade at a steep discount to their historical averages, and crucially, there are signs that sentiment is starting to shift. While the rest of the market is notching new all-time highs seemingly every day with increasingly stretched valuations, why wouldn’t you put some money to work in MLPs?