MLPs: The Place to Be in 2013

Stocks are drifting higher in that wonderful, irrepressible holiday spirit we see almost every December. The Dow gained 78 points on Tuesday, for instance, and probably would have gained even more (the index was up 136 points in the morning) but for some Grinch-like remarks by Senate Majority Leader Harry Reid concerning fiscal cliff negotiations.
Absent a sudden, unexpected breakdown in the negotiations, sheer momentum buying — the dog chasing the car — will likely take the market up a few more notches through the end of the month. The benchmark S&P 500 should reach 1,440 at least, with 1,470 a target in January if Congress and President Obama can seal a bargain, however limited in scope.
I’m quite content to ride this wave as far as it will carry us. However, I can’t escape the sneaking suspicion that Mr. Market will deal investors a jolt or two in 2013.
Luckily for investors, there are a few hiding places left.

Risks in 2013

Corporate profit margins have peaked for the current business cycle, which means earnings growth will be much more difficult to come by in the New Year. Analysts’ year-ahead estimates for many companies — and for the market as a whole — are probably too high.
And it wouldn’t take a meteorite from outer space to shatter the fragile optimism that has built up on Wall Street. A simple downshift in earnings expectations could quickly lop off 10% to 15% from the S&P, and an outright recession — triggered, perhaps, by a poorly structured fiscal compromise — would hurt even more.
Given these risks, I suggest you stick with the policy we’ve followed all year: buying stocks and mutual funds on pronounced weakness and peeling off a portion of your holdings as the market rises. We were active buyers in May and early June, and again in November. If prices continue to tick higher this month and into January, you can assume I’ll have some sell signals for you.
Meanwhile, we’re still buying, but much more cautiously and selectively. One group worth trolling in is the master limited partnerships.

MLPs Are the Place to Be

Chances are Congress will leave the tax status of MLPs untouched. According to the congressional Joint Committee on Taxation, the current tax treatment of MLPs only costs the Treasury approximately $1 billion in lost revenue over five years — a mere speck compared with the government’s annual $1 trillion budget deficit.
Moreover, with all the hoopla about the coming era of American energy independence, will Congress really want to squash this industry, which is building out our energy infrastructure and creating good, high-paying jobs?
If you don’t need current cash income, one way to get exposure to MLPs is though Kinder Morgan Management (NYSE:KMR). Based on the implied value of the stock distribution, KMR is yielding 6.8%. In a recent article on pipeline MLPs, I highlighed KMR and Enbridge Energy Management (NYSE:EEQ) as ways to play MLPs in an IRA account, but I expect EEQ’s distributions to grow more slowly than KMR’s in the next year or two.
KMR follows the performance of the underlying pipeline MLP Kinder Morgan Energy Partners LP (NYSE:KMP), but it can be held in an IRA and pays quarterly distributions in stock — shares of KMP — rather than cash.
The stock distributions are totally tax-free until you sell. When you sell, any profit is treated as a capital gain (a tax-favored long-term gain if you hold the units more than a year).