The Coming Bubble in MLPs
by Marc Lichtenfeld, Investment U Senior Analyst
Wednesday, February 15, 2012: Issue #1709
It was difficult to make a buck in 2011. Those who had a job thanked their lucky stars.
And if you had some capital to invest, trying to turn a profit was just brutal. The Dow was up 5.5% for the year, but it sure didn’t feel like it. The S&P 500 finished almost exactly where it ended 2010. In fact, it was just 0.04 points away from the final 2010 number. The Nasdaq was down 1.8%.
Gold gained 10%, but went through some wild swings, punishing investors who jumped on the bandwagon.
And if you wanted to simply sit back and collect interest, good luck. Money markets, CDs and savings accounts yielded next to nothing. Treasuries weren’t much better.
So it’s no surprise that investors started to rediscover dividend-paying stocks as the one place they could make a few dollars.
I expect that trend to continue in a big way this year. In fact, in December, I made several predictions for 2012. Among them, MLPs (master limited partnerships) would become trendy.
The more I think about it, the more I’m convinced this class of stocks will not only be trendy, but become white hot to the point where pundits will be using the “B” word – “bubble.”
Several factors will lead to the “bubblicious” gains in these stocks, which are usually energy related.
- Investors’ desperate search for income – Dividend stocks were all the rage in 2011 as investors tried to get yield anywhere they could find it. MLPs typically have yields above 5% since they must distribute all of their income back to unit-holders in order to avoid corporate taxes. The result is a yield that’s greater than the typical dividend-paying stock.
- Energy experts Dave Fessler and Matt Carr expect energy prices to rise in 2012 – For some MLPs, the price of oil and gas doesn’t matter as they simply transport the stuff from point A to point B. For others it does, and higher prices mean higher profits and higher payouts to unit-holders.
- Tax deferred strategy – Most, if not all, of MLPs’ distributions are usually not taxed by the IRS as ordinary dividends. Instead, they’re treated as a return of capital. This lowers your cost basis, which could increase your capital gains when you sell the stock. But while you’re collecting the cash distribution, you won’t be taxed on the distribution in the year you receive it. That can be attractive, particularly those in higher tax brackets.
- Media frenzy – For all of the above reasons, I expect MLPs to get hot in 2012. The media will surely notice. Soon, you’ll see MLPs being talked about in the mainstream financial press, which will lead to more interest by investors, which will cause the stocks to go higher, which will generate more media attention.
I think the sector will get so hot, you’ll first see the naysayers come out, and then the believers forcefully defend their beloved MLPs. At some point the sector will drop and the bears will say, “I told you so.”
But their satisfaction will only last until the face-ripping rally that will come next as investors jump in on the newly created buying opportunity. The stragglers will keep the rally going, as they don’t want to be left out of the next great thing.
All of this attention will lead to utterances of the “B” word by the end of the year.
But a bubble isn’t always a bad thing – if you’re in early enough and get out when things get frothy.
If you’re interested in MLPs, take a look at companies like Williams Partners (NYSE: WPZ), Enbridge Energy (NYSE: EEP) and Buckeye Partners (NYSE: BPL)
I’m very bullish on MLPs right now. With those higher than average yields, if 2012 is a repeat of last year, MLPs might be one of the few places to make some real money this year.
Good Investing,
Marc Lichtenfeld
Any investment contains risk. Please see our disclaimer.
7 Responses to “The Coming Bubble in MLPs”
Comments
By submitting your comment you agree to adhere to our Comment Policy and Privacy Policy.
Check out our selection of daily investment research:
 |
 |
Marc is a senior analyst at Investment U. His investment career started out at the trading desk of Carlin Equities in San Francisco, CA, where he executed dozens of trades each day for his clients.
Even though MLPs have the word “Limited” in their monicker, are they not actually NOT limited where it involves any potential liability? Correct me if that is wrong. But if I am correct then any investor could become liable for say, a large oil spill by a company in the MLP. Something like that could totally wipe out the finances of the average mainstreet investor.
Reply
Jeff,
Thanks for the question.
MLPs are actually very similar to stocks in that the unitholders, like shareholders of a stock, do NOT carry much liability at all.
The only liability is that if the MLP makes a distribution to you, and later one of its creditors feels that the distribution was unlawful, the creditor can take back the “unlawful” distribution. Therefore you can’t lose any more than your dividend profit.
Thanks,
Investment U Team
Reply
HI
well I have owned several MLP for years plus Clearbridge ETF which owns more
But I think you are likely to be late – I see that now the EPA is snooping around the Marcellus looking for reasons to shut down fracking – already have claimed problems in Wyoming – The Obama administration will do all possible both to eliminate what they call ‘tax loopholes’ and cheap energy that defeats the wind and solar lobby.
best wishes
Reply
Marc, Wonder what your thoughts and those of all subscribers are on MLP funds like the Alerian MLP Index Fund? My guess when the bubble burst in individial MLPS the funds obviously will take a dive also?
Reply
Marc. As an ira investor in some mlps, there is a potential tax liability for distrbuton that are considered unrelated businees income over $1000 per year. Do you know which mlps have the lowest urbi based upon previous k_1
Reply
I bought several MLPs in 2009, and they have already had quite a run. More recently I have put funds in MLPL, which is a leveraged ETF of MLPs. This avoids the tax reporting (K-1s; and URBI for those who put it in an IRA or other pension account), still has a nice yield, and gives one diversification. It’s up about 50% since I bought some, but may still have room to grow if the author here is correct.
Reply
As someone who has been actively investing in these since they first came out 10 yrs ago I am happy to see a contranian viewpoint. One thing is that they are all not created equal sometime searching for yield alone is a poor approach. Look at say the differene between NS one of the older higher yields and OKS. It is a trickier game and the advent of closed end funds into this arena has made selection even more difficult. Please note the tend to be great buys in major market declines like in 2008 – 2009 as suggested above. One final point is domestic production will ultimately have to be a solution and still believe natural gas has a valid future in american energy policy. These factors should work well for pipelines over the next next 10yrs absent of higher oil prices.
Reply