The changes in the global economy over the last decade have completely transformed the primary sources of wealth creation. In the 1980s and 1990s, equities, real estate, and bonds drove wealth creation. This millennium’s top asset classes are led by commodities, like gold and oil, emerging markets, and Master Limited Partnership.
Since the 1980 and 1990, when U.S. equities, real estate, and bonds were performance leaders, U.S. equity performance has shifted from the high teens to flat; real estate has entered a secular bear market; and bonds– which have enjoyed a secular decline in inflation–now struggle with inflation, credit quality issues, and unattractive yields.
This decade’s leading asset classes are now producing the types of returns that U.S. equities, real estate, and bonds generated in the 1980s and 1990s. Gold has entered a bull market, in 2001, and risen from $271 to over $1500/troy oz. of gold and returned 19.5% annualized. Oil (West Texas Intermediate) has risen from $12 a barrel in 2002 to over $100 returning an annualized 18.4%. Emerging markets entered a bull market in September 2001 with the MSCI Emerging Market Index appreciating from 251 to 1146 an annualized 16.8% return; and Master Limited Partnerships (MLPs) have returned 16.24% annualized since 1995.
Knowing asset class performance offers limited value in identifying future wealth creation investments. The logical pathway to wealth creation and preservation is to understand the global fundamental factors that drive asset performance. The macroeconomic trends that now drive asset performance are debt deflation, emerging market growth, and global monetary stimulus.
Debt deflation is the consequence of financially overextended countries, their states, and municipalities, as well as the 25% of U.S. homes which are valued at or below their mortgages. Debt deflation is flipside of a massive debt accumulation which enhanced global economic growth in the last decades of the 20th Century. Now, overleveraged balance sheets are forcing budget cuts, reduced spending, and creating economic headwinds. This condition will last years and is our generational equivalent to the Great Depression. Emerging market growth driven by the transformation of the emerging markets to modern industrial economies will dwarf the influence that baby boomers had on the U.S. economy in the last century. Combined, China and India have a 2.6 billion person population coming into the modern age. The economic consequence of more than 10 times the population of the United States moving into middle class economies will profoundly affect consumer spending, commodity consumption, and investment globally in the decades ahead. Lastly, government fiscal mismanagement is leading to monetary behavior of dubious foresight. The global monetary stimulus from financially overleveraged countries like the United States will likely contribute to hard asset and commodity inflation, currency revaluation, and economic instability.
True wealth is measured by an asset’s cash-flow generating capacity. In a debt deflation, the most attractive assets generate predictable growing income streams. We believe that that portfolios based on growing income investments–especially those that benefit from global fundamental factors–will be a leading source of wealth creation over the next decade. This is investment philosophy led to the founding and naming of Income Growth Advisors, LLC.
If an asset cannot generate income, then you risk engaging in a greater fool’s game where by you are speculating in an asset bubble. The Internet Bubble, the stock market crashes of 2000-2003 and 2008-9, and the real estate collapse are last decade’s painful examples of asset bubbles and the new investment environment. Yale Professor Robert Shiller’s work suggests the S&P 500 is 34% priced above its fair value and residential real estate has as much as 25% further downside. Frankly, we fear that bonds could have similar downside risk, if not more, depending on inflation.
Our firm’s objective is to guide our clients into assets with predictable growing income streams for their retirement planning and wealth creation. Master Limited Partnerships (MLPs) exemplify this type of asset. MLPs benefit from the need to transport energy throughout the United States. Midstream Energy MLPs own the pipeline networks that transport oil from Alaska, Canada, and Gulf of Mexico ports as
well as natural gas and liquids throughout the country. Steady growth in energy consumption and population drive steady increasing cash flows that flow through to limited partners in steady growing tax advantaged distributions. MLPs benefit from two powerful secular growth trends–the development of the Canadian Tar Sands and new domestic natural gas discoveries. These two domestic energy growth stories will lead to massive natural gas and petroleum distillate transportation, processing, and storage investment for the coming decades.
Ten years of MLP investment experience has given us unique and valuable experience for identifying the faster growing, higher yielding, and stronger long term growth opportunities in this sector. For example, Terra Nitrogen Company LP (TNH) is one of the country’s largest fertilizer manufacturers. While not a traditional pipeline MLP, TNH offers a 14% yield, ramping earnings, and is a direct beneficiary of American agriculture growth. With increasing global food demand and inflation driving higher food prices, we view agricultural growth as an important global growth theme. TNH offers logical diversification to an energy oriented MLP portfolio. To participate in Canada’s Tar Sands we like Enbridge Inc. (ENB) which is a dividend growth stock. ENB has two MLP subsidiaries Enbridge Energy Partners (EEP) and Enbridge Energy Management (EEQ) for retirement plans. Chesapeake Partners (CHKM), is one of our favorite plays on the natural gas boom in America. CHKM has a five year CAGR distribution growth rate Goldman Sachs estimates at 22% and currently yields 4.9%. CHKM’s parent is an aggressive leader in the development of natural gas in the US and should lead to many future asset drop downs that will drive distribution growth in the future.
MLPs are fully valued at this time. However, there are three other income growth themes or sectors which provide portfolio diversification. Domestic and international wireless telephone operators which are deriving good growth from strong cell phone, smart phone, and tablet usage. Several of these operators offer attractive dividend yields, dividend growth prospects, long term earnings prospects, and good charts. The pharmaceutical sector, too, have stocks which meet these criteria and appear to be rebounding from a sector bear market related to concerns related to major drugs losing their patents. Lastly, the confluence of emerging market growth with the massive monetary stimulus is helping to drive commodity prices higher. Investments that link commodity prices to growing income profiles are ideal candidates for our portfolios. For example, Southern Copper Corporation (SCCO), pays out the bulk of their earnings in dividends, yields 7%, and is a play on China, emerging market growth, and copper consumption. Investments in coal should also benefit from rising energy demand, energy independence, and commodity inflation. Alliance Holdings GP (AHGP) and Alliance Resource LP (ARLP) are two we like.
We are close to completing our model portfolio of 30 MLPs and dividend growth stocks that can yield 6.25% and can double its yield in about 7 to 8 years. By creating portfolios with dividend growth in the 10% range, the rule of 72 states that dividends or distributions will double in 7.2 years. Our experience in MLPs, quantitative research methodologies, and investment strategy will allow us to construct portfolios which should yield 5-8% and double the income paid to our clients in 7 to 8 years. Our goal would be then to quadruple your income in 15 years, through our focus on income growth. We believe a portfolio return profile like this will significantly exceed the returns from stocks, bonds, and real estate, and will lead in future asset performance comparisons. Additionally, the income visibility will be helpful in retirement and wealth planning.
Sincerely,
Tyson Halsey, CFA
Managing Member