The Vicious Mark-Down Of MLPs; Comparing Yields From Early 2000 by Evergreen Gavekal Capital
“There is no training, classroom or otherwise, that can prepare for trading the last third of a move, whether it’s the end of a bull market or the end of a bear market.” – Paul Tudor Jones, one of America’s most successful hedge fund managers.
- The emotional parallels between today and the end of the late 1990s bull market are striking. It’s a trying time for value-oriented investors as richly-valued stocks continue to rally in the face of weakening fundamentals, a painful commodity bust, and shaky credit conditions.
- Believe it or not, in the long-run valuations do matter. I’ve learned over the course of several decades that if you radically overpay for stocks, and don’t get out in time, you are going to lose money… even if you remain invested for many years.
- Fortunately, markets rarely correct all at once. Even in a clearly overpriced market, opportunities can emerge that offer attractive current yields, the potential for compelling long-term returns, and meaningful margins of safety versus high-flying momentum stocks.
- Just as previously beaten-up assets dramatically outperformed the NASDAQ from 2000 to 2002, today’s laggards will likely become tomorrow’s leaders. Investing in out-of-favor asset classes like MLPs, energy stocks, Canadian REITs, and high-grade/high-yield bonds demands enormous discipline and great courage at this point in the cycle. But I believe these positions – alongside large cash reserves and a healthy allocation to US Treasuries – offer the best way forward as the bull market takes its dying breaths.
The more things change…A stock market led by a shrinking number of outrageously high PE stocks. Margin debt rolling over from an unprecedented peak. A formerly thermo-nuclear IPO market notably cooling. Stocks selling for one of the loftiest price-to-sales ratios ever. Real estate values in Seattle and Silicon Valley at silly-high levels. The US dollar rocketing, especially against emerging market currencies. Credit spreads expanding dramatically. A lengthy economic expansion appearing increasingly winded. Oil prices trading well below production costs. Master Limited Partnerships (MLPs) under severe pressure. This all sounds a lot like current conditions, right?
The answer is yes, but it’s not the period that has been circling back to my mind like an expertly-thrown boomerang. Rather, I’m referring to early 2000, when the biggest stock bubble in history was about ready to meet its maker.
One of the reasons I’ve been reflecting on that era so frequently of late is the similarity with how I felt then compared with now. Few EVA readers knew me in those days, so my constant verbal warnings—along with a few of my newsletters calling out the bubble—have mostly disappeared into nothingness (as have many of the most popular stocks of that era!). But I can assure you I will never forget the year-after-year discomfort, starting in mid-1997, when I began to feel like I was trapped between my value-oriented DNA and one of the greatest greed cycles of all time. Unfortunately, for my psyche—not to mention my poor wife—unhappy days are here again, at least in our household.
As my partner, Charles Gave, likes to say, a bubble is a market in which you’re underinvested and a bull market is one that you’re riding like Slim Pickens in “Dr. Strangelove” (okay, I paraphrased Charles on that last part). Actually, though, the metaphor works pretty well because, at the end of Stanley Kubrick’s classic tragicomic film about a nuclear game of chicken, Pickens’ character is yee-hawing on top of an atomic bomb as it plummets toward Mother Earth—which also happens to be Mother Russia. And that’s exactly what anyone who was riding tech stocks in early 2000 was doing—blithely joy-riding on the financial market equivalent of a nuclear payload.
Meanwhile, your EVA author was apologizing on a daily basis for earning 10% to 15%-type returns when 50% plus was as commonplace as new-issue dot.coms (which, back to my analogy, soon became known as dot.bombs). In addition, a relatively new asset class—MLPs—of which I had become increasingly fond, was not only lagging the overall market, they were actually declining. As a result, cash flow returns of 10% or more were routinely available. Pretty much anything that was viewed as part of the “old economy”—and all things energy-related certainly were—was being marked down, often to ridiculously cheap prices (and high yields in the case of MLPs).
It was exponentially embarrassing to be holding securities that were declining when the overall stock market and, especially, the NASDAQ, were going vertically asymptotic—a fancy phrase for straight up. Well, as the French like to say, the more things change, the more they remain the same.
When a boom was truly a boom. As indicated in the opening paragraph, there are a considerable number of parallels today with the tail-end of the 1990s bull market, including that the NASDAQ—led by a select group of super-high P/E stocks—is the star. Another echo is how universally detested emerging markets are, just as they were 15 years ago in the wake of the Asian crisis (when Hong Kong housing prices tanked by 75%!).
Yet, there are some striking differences as well. For one thing, interest rates actually existed back in 2000. T-bills were yielding around 5% and 10-year treasury notes were returning close to 6%. The Federal government was churning out large and consistent surpluses, causing former Fed Chairman Alan Greenspan to publicly fret that Treasury bond market liquidity might be seriously impaired as most of America’s debt would be retired by 2010. Suffice to say, he was just a little wide of the mark with that forecast.
Virtually all large growth companies, including a number that were not tech stocks, were trading at ridiculously lofty valuations in those days. This is another contrast with now. Today, most large cap growth stocks—outside of a select group of cult issues sporting 1999-type P/Es—are not glaringly expensive and some look downright reasonable (including Forrest Gump’s favorite “fruit” company.)
Another difference was the swelling level of societal confidence. At the turn of the millennia, America stood supreme around the world and our national self-confidence was at a high rarely seen in the post-WWII era. Additionally, the US was not yet demographically-challenged and our economy had just enjoyed a wonderful decade of 3.3% GDP growth (unlike the measly 1.5% we’ve endured over the past ten years). Productivity, the essential ingredient for a society’s prosperity, had been improving at a rate unseen since the go-go days of the 1960s. In short, it was a real boom…in glaring contrast to the current economic dud whose fuse policymakers have been trying in vain to light for years.
Regrettably, like all such periods of euphoria and soaring asset prices, it came to an abrupt end. The tech bubble crash was the first dagger to the heart and then the 9/11 tragedy applied the coup de grace. As a result, America’s sense of self-assurance and limitless prosperity vaporized almost overnight.
Yet, in point of fact, most stocks had begun to crack in the spring of 1998, a full two years prior to the tech wreck and over three years before September 11th. This brings up another difference compared with today: By early 2000, most small- and mid-cap stocks, particularly of a value nature, were