Compression in interest rates helps MLP stocks

2013.02.26 - GT10 STEnlarge GraphInvestors who hold master limited partnership (MLP) stocks often monitor interest rates on Treasury bonds. This is because many investors hold MLP stocks for the distribution or “yield” component of the securities. US government Treasury yields are relevant because if rates on the bonds increase, investors should expect rates on MLPs to theoretically increase as well. This is because many view US Treasurys as one of the safest yielding investments in the financial universe, and if the rates on Treasurys increase, the yield required from MLPs (and all other yield instruments) should also theoretically increase. When the yield on MLPs increases, the price and valuation of MLPs decrease.

The yield on the benchmark ten year Treasury moved from 2.003% to 1.963% for the week ending February 22. Treasury bonds have weakened somewhat from mid-2012 to present as seen in the above graph.

However, in the context of a longer time period, Treasury yields are still close to all-time lows. The below graph shows historic yields on the ten year Treasury from the beginning of 2001 to present.

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One can see that only in the past few years the ten year Treasury has yielded below 2%. This is mostly a consequence of the Federal Reserve pumping money and liquidity into the financial system. The below graph shows the yields on the Alerian MLP Index versus ten year Treasury yields.

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Except for the period of the financial crisis, where investors pulled money out of riskier investments such as equities (which MLPs are) and poured it into cash and Treasuries, MLP yields have often moved directionally the same as Treasury yields.

The slight movement downward in Treasury yields this past week is theoretically a short-term positive for MLPs. Many market participants believe that rates will not rise significantly in the short to medium term as the Federal Reserve continues to keep rates low given the current shaky nature of the US economy and relatively high unemployment. However, in the longer term context, it has oft been said that “rates only have one direction to go”. If rates eventually rise for example to pre-recession levels of 4-5%, it could be a negative for MLPs and the Alerian MLP Index (AMLP). Major names in the index include Enterprise Products Partners (EPD), Kinder Morgan Energy Partners (KMP), Magellan Midstream Partners (MMP), and Plains All American Pipeline (PAA). Therefore, owners of MLPs should be aware of rate movements and how they affect MLPs.