MLPs: Upside Potential if Interest Rates Climb?

Three broad trends jump out at me right now that should be of interest to investors seeking relatively conservative growth and income investments right now. Specifically, I’m looking at Master Limited Partnerships (MLPs).Federal-Reserve-DC
MLPs typically aren’t considered “growth” investments. But if we look forward a few months I think the confluence of three trends will mean MLPs outperform the broad market. And given what I perceive to be somewhat limited downside, I think even traditional growth investors should consider dabbling in the space.
So what are the three trends?
First is the seeming stability that has entered the oil market. Note that I say “seeming.” We all know that things can change quickly when it comes to oil prices.
But as this 1-year chart shows, after falling over 50% from its 2014 high, oil seems to have found support around the $48-$50 level.
If this level truly does become a base, then oil-related investments have significant upside should the price of oil rise. I don’t know where the price of oil will go any better than the next analyst, but given the commodity’s history I feel comfortable investing in oil-related stocks right now. For example, I’ve personally invested in Chevron (NYSE: CVS) recently.
The second trend is the increasing likelihood of the Federal Reserve raising interest rates later this year. While this ultimately should be positive for the stock market, that positive trend historically comes after a bumpy ride. At least that’s been the case the last three times the Fed hiked rates.
Research from Credit Suisse (NYSE: CS) suggests the S&P 500 will fall by around 10% from peak to trough after the Fed’s first rate hike. Usually this decline happens within two to six months (I’m using the 1994, 1999 and 2004 rate hikes as a sample size).
It’s reasonable for investors to be prepared for this, and perhaps even go so far as to plan for it. Buying conservative investments ahead of the possible hike, and adding more exposure after it, is a rational way for investors to position themselves to profit when the market eventually climbs again – which typically does happen after that initial drop.
And this brings us to the third trend, which is the potential for MLPs to outperform after Fed rate hikes.
The last two times the Fed raised rates (2004 and 2007) MLPs outperformed the S&P 500. Add in the potential for MLPs to raise distributions and the asset class becomes even more attractive.
Finally, considering that MLPs have underperformed in 2014, there is potential for some catch-up performance in 2015.
Certainly there are no guarantees here. Oil prices could fall further or the interest rates may not go up in 2015. And even if those two trends do come to pass, MLPs might not outperform the third time around.
But I think the asset class is pretty compelling right now. The Alerian MLP Index, which includes 50 MLPs, currently yields 6.17%. And after falling over 15% from its 2014 high, there is potential for capital gains in many of the index constituents should oil prices indeed rise.
I think it’s a compelling proposition. And I’m adding exposure to MLPs right now to try and take advantage of the opportunity. I don’t expect to make a truckload of money tomorrow, but over the next 12 to 18 months I expect that these MLP investments will outperform the S&P 500 and even many “growth” investments.

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