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Income Investing

Macro Income Talk

By Roger S. Conrad, on Oct. 11, 2017

First and foremost, Capitalist Times Premium is devoted to helping our subscribers buy the best stocks at the best prices. The publication also aims to provide the tactical nous to weather the market’s inevitable storms while avoiding major blow-ups that result in permanent loss of capital.

To this end, we monitor macro developments that could affect our holdings, including trends in the global economy and relevant political news. Technical factors also come under consideration, from momentum-based indicators to the composition of a company’s shareholder base.

But our process of selecting stocks for the model Portfolio hinges on rigorous, bottom-up analysis. Although we don’t build the Portfolio from 30,000 feet, we do incorporate our understanding of the macro environment to improve our odds of buying low and, in some cases, taking profits when valuations reach unsustainably high levels.

In contrast, investors who primarily buy exchange-traded funds (ETF) and other investment vehicles that offer one-stop exposure to a theme or group of stocks necessarily bet on macro and, to a lesser extent, technical factors.

A sharp run-up in an individual stock can boost an index or ETF’s return, but the other stocks in these baskets will dilute this outperformance. And if market sentiment sours on the particular theme to which an ETF offers exposure, stocks that feature prominently in those passive strategies will suffer disproportionately.

The Good, The Bad and The Ugly

Consider the rollercoaster ride that master limited partnerships (MLP) have endured over the past five years.

Conservatively run Lifelong Income Portfolio member Enterprise Products Partners LP (NYSE: EPD) remains the gold standard among US midstream operators, blessed with a prescient management team, strong balance sheet and an integrated asset base that touches almost every link in the energy value chain. The blue-chip MLP has continued to grow its distribution at the same steady pace, regardless of what happens in equity and commodity markets.

This resilience stands out at a time when many larger midstream operators—Kinder Morgan (NYSE: KMI), Energy Transfer Partners LP (NYSE: ETP), Plains All-American Pipeline LP (NYSE: PAA) and Williams Partners LP (NYSE: WPZ)—have slashed their distributions.

For all its fundamental strength, Enterprise Products Partners has still given up about 24 percent of its value since the Alerian MLP Index’s peak in Aug. 29, 2014. Although this return easily beats the index’s 38 percent loss over the same period, it doesn’t come close to the S&P 500’s 31 percent gain.

Much of this downside likely stems from Enterprise Products Partners’ heavy weighting in the Alerian MLP Index (20.9 percent, currently) and the more than 80 funds that offer significant exposure to this universe of about 100 stocks. Meanwhile, Dominion Midstream Partners LP (NYSE: DM), which gets a negligible allocation in the capitalization-weighted Alerian MLP Index, has returned more than 54 percent since its initial public offering in October 2014.

By the same token, Enterprise Products Partners and other large-cap MLPs benefited disproportionately from inflows into ETFs and other fund products—one of the reasons we suggested that investors avoid the overpriced stock and consider taking some profits off the table after attending the National Association of Publicly Traded Partnerships’ 2014 investor conference.

ETF buyers should focus on the macro and technical factors driving the performance of certain sectors or themes; owners of individual stocks should always understand what they own while casting a wary eye on the bigger picture.

Reputational damage from a raft of distribution cuts and concerns about oil prices continue to weigh on investor sentiment toward MLPs, making this group one of the few places in the market where investors can find value and lock in big yields. Many midstream operators have taken their medicine and should be able to maintain, or even grow, their payouts through the volatility.

But sentiment toward the group could take a while to recover while the likes of Energy Transfer Partners, Plains All-American Pipeline and Williams Partners reduce risk and nurse their balance sheet back to health.

The Dow Jones Utility Average has fared much better than the Alerian MLP Index in recent years, with some of the capital flowing into the sector probably coming from badly burned MLP investors. Utilities Select Sector SPDR (NYSE: XLU) continues to attract inflows and recently broke out to a new high; on the year, the ETF has returned 15.8 percent.

This momentum reflects robust demand for utilities’ above-average yields and operational resilience. As with Enterprise Products Partners, NextEra Energy (NYSE: NEE) and other large-cap names that feature prominently in utility- and dividend-focused funds have benefited disproportionately from money sloshing into these passive strategies.

State of the Utility Sector

Since US equities bottomed in March 2009, the Dow Jones Utility Average has tripled in value—and that’s before you factor in dividends that have grown at an accelerating rate in recent years.

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