Coronavirus and OPEC Black Swans Create Rare 1987-like Opportunity in MLPs

The continued worsening news due to COVID-19 and Oil prices have led to generational declines in the stock and oil markets. Like 1987, and other major declines, rare opportunities to buy distressed mispriced securities are at hand. This week saw positive news regarding COVID-19 and Oil Prices, which paused the rapid declines in both the S&P 500 and oil; the feedback loop of bad news and computerized selling halted and created an inflection point in this global market meltdown. This inflection point in the market’s rate of decline suggests the beginnings of a market bottom and an opportunity for those steely nerved investors.

Kayne Anderson Midstream MLP Company—KYN with a discount to NAV of 21% and 41% yield and Kayne Anderson Midstream Energy Fund—KMF with a discount to NAV of 30.5% and 43% yield offer compelling risk-return potential.

Source: USOIL Charts and Quotes – TradingView

The S&P 500 dropped 33% in one month.

Source: Interactive Brokers TraderWorkstation

This is the fastest decline of any in history. Faster than 1929, 1987, 2008…

Source: ClearBridge Investments

The global response to COVID-19 is providing multiple avenues of a possible cure for the virus. Hydroxyquinoline news is one of several promising antidotes or solutions which is helping to create the hope that this virus will be conquered. With the total number of deaths from COVID-19 across the world having surpassed 10,000 and the total number of confirmed COVID-19 cases across the globe standing at 244,000, the simple fact that progress is being made fighting this virus improves the probabilities for a resolution to this health crisis, turning panic to calm.COVID-19 has run its course in Wuhan, China. This fact provides hope, medical data and statistics to stop its spread and to lessen its impact. Likewise, South Korea took rapid intrusive measures and they have worked.

Safe distancing protocols are slowing the spread of COVID-19.

Last week witnessed the engagement of the United States in the OPEC oil crisis with the Texas Railroad Commission to meet with Saudi Arabian and Russian counterparts to stabilize oil’s price. US oil production has been a significant economic engine, and the current OPEC spat threatens to bankrupt many oil companies adding to the economic slowdown caused by COVID-19.

Both COVID-19 and the decline in oil are problems that will be resolved in time. Consequently, timing the market’s bottom is the key market issue. When the US bends the curve on COVID-19 and or OPEC rebalances market shares, global markets will begin to normalize. This week’s news changed the trajectory of the stock and oil market declines, which slowed the negative feedback loop of bad news and market panic.

Both COVID-19 and the decline in oil are problems that will be resolved in time. Consequently, timing the market’s bottom is the key market issue. When the US bends the curve on COVID-19 and or OPEC rebalances market shares, global markets will begin to normalize. This week’s news changed the trajectory of the stock and oil market declines, which slowed the negative feedback loop of bad news and market panic.

Both KYN and KMF saw a 95% price drop in the last 30 days, before doubling of their bottoms March 18th, 2020. Should they return to yields of 9%, these funds could nearly triple, before you count the 40% yields.

Source Yahoo Finance.

In market crises, MLPs are often subject to deleveraging, quantitative, ETF, index and indiscriminate selling. Kayne Anderson reported MLP sales, risk mitigation and distribution coverage actions to reduce leverage in KYN and KMF and maintain their high yields. Goldman Sachs also unwound some leveraged MLP strategies.

It this institutional de-risking that has caused the extreme pressure on the MLP sector, this opportunity and valuation level. These factors led to the extraordinarily low prices in these predictable high yield investments. The MLP sector should improve from these extreme oversold levels.

The charts below illustrate that MLPs have had severe sell-offs in the past, often occurring in conjunction with stock and oil market plunges. Since the buyers of KMF and KYN will be yield seekers, these investors are not forecasting the same earning and economic risks that challenge common stock investments. It is the unique combination of earnings quality and high yield that will drive the sharp returns in MLPs following this decline.

Off the 2008 low, the MLP index rose 385% or 44.9% for over three years. Off the 2016 low, MLPs returned 77%. The returns below are very attractive and correlate with yield normalizations.

The databox below shows the risk premium in 2008, 2000, 2012 and today of 7.15%, 6.61%, 6.61% and 5.38%, respectively. The risk premium is the difference between the earnings yield of the S&P 500 and the 10 year US Treasury yield. The earnings yield measures how much earnings is generated by a dollar’s worth of the S&P 500. Today the S&P 500 earnings yield is 6.33%. In 2008, 2009 and 2012, the databox below shows it was 10.32%, 9.44%, 8.18%.

These MLP market factors suggest that the MLP market is at lows and all the forced liquidation is complete.

Historic market panics like this offer a rare opportunity for those investors who can distinguish between the price of an investment and the value of that investment. We see an unusual opportunity in MLPs and are buying diversified MLP funds KYN and KMF for our clients. Their distribution coverage, cash flow stability, and risk mitigation through a diversified portfolio provides an unprecedented risk to reward proposition of 100-300% to informed investors.