It’s been said that the last stages of a bear market involve capitulation by the remaining holdouts as they finally walk away in disgust. But in a way, it’s like the advice to buy when there is blood in the streets. OK, but how much blood? There was blood in the streets a year ago. Little did we know there was going to be a lot more spilled.

To me it has felt like capitulation in the MLP space for months. Each time I think we are at a bottom, the market falls a bit more. Last week The Organization of Petroleum Exporting Countries (OPEC) agreed to continue producing crude at a rate well above its production quotas. Although there should be no practical effect on oil supply — OPEC members have already been pumping all-out — the tone was more bearish than expected, once again disappointing hopes for a quick recovery in oil prices. West Texas Intermediate (WTI) slumped 6% to less than $38 a barrel Monday as the reality of ample overseas supply sank in.

In addition to the drag from slumping prices, we are also likely to see some year-end tax selling by those looking to offset gains elsewhere in their portfolios. (I recently discussed my strategy for locking in those losses in “Turning an Oil Loss Into a Tax Win.”) This may put some additional pressure on the MLP sector through the end of the month.

Is there any good news to report? There is one silver lining in the dark clouds. As I write this, the Alerian MLP Index (AMZ) has a year-to-date total return of -43.5%. If that stands, it will be the worst performance on record. The worst year prior to this was 2008, which closed with a total return of -36.9%, and which was the only other year in the past decade with a loss for the index:

Source: Alerian

But MLPs followed up that 36.9% loss in 2008 with a 76.4% gain in 2009 and a 35.9% gain in 2010. Of course we all know the adage about past performance being no indicator of future results. Further, oil prices also rallied strongly in 2009, while I expect a much more tepid recovery in 2016.

Nevertheless, despite the extreme market negativity, the sector is still generating and distributing cash at a rate that would suggest a lot of value has been wrongly discounted at current levels. So there is reason for optimism in 2016.

I would point out that in the past 15 years, there was only one other year in which the AMZ had a negative return. Following a 43.7% gain in 2001, the index lost 3.4% in 2002. It followed that up with a 44.5% return in 2003. Unfortunately, sentiment is significantly more negative now that it was then, or even at the end of 2008. But there is nothing from history — nor from the sector fundamentals — that would suggest anything but a positive return in 2016.   

In the meantime, I feel your pain. I did some tax-related selling of the MLP sector two weeks ago, locking in double-digit losses. However, I will be looking for a reentry point later in December as I expect the sector to rise in 2016 even if commodity prices remain weak.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Kinder’s Nasty Surprise        

Midstream pipeline stocks are in the throes of  full-fledged panic fanned by Friday’s notice from Kinder Morgan (NYSE: KMI) that its 2016 dividend is very much in doubt.

In a news release announcing its 2016 financial expectations, Kinder forecast distributable cash flow “of slightly over $5 billion,” sufficient to finance its prior outlook for dividend growth of 6-10%. “Alternatively, this cash flow can be used to fund some or all of KMI’s equity needs for 2016,” the statement continued.

Those needs are likely to exceed $2 billion on top of the recent $1.6 billion convertible offering,  based on the $3.5 billion in capital spending Kinder budgeted this year, and the $4.5 billion Moody’s expects it to spend on capital projects next year.

Kinder does have a virtually untapped $4 billion credit line expiring in 2019. But the company said Friday it intends “to take required action to maintain investment grade rating and stable outlook,” which would seem to take further borrowing off the table in the wake of a negative credit outlook issued early last week by Moody’s.

Kinder Morgan’s debt to EBITDA ratio is already uncomfortably high at 5.8x, and losing the investment-grade rating risks further jeopardizing its access to debt markets.

With a spending shortfall of some $2 billion that has become uneconomical to finance with equity and that Kinder won’t finance with extra debt, something has got to give. And Friday’s statement was a clear warning that the dividend will be that something,

The company is caught in a negative feedback loop where its financing needs are causing its share price to plummet, which in turn is aggravating its financing needs by making equity issuance ever more impractical.

The silver lining is that there is solid business on sale here throwing off $5 billion in annual cash flow with limited commodity exposure, and with capital spending needs that should diminish in the coming years as energy infrastructure catches up with the recently stalled North American output.

Cutting the 2016 dividend, as Kinder is likely to do, will allow it to finance projects without further diluting shareholders with low-priced equity, and without further leveraging the balance sheet. Given the recent market action, such an action will not come as a surprise to investors either, and may already be fully discounted in the share price. Buy KMI below the reduced limit of $25.   

— Igor Greenwald