May 20, 2010, was a rough day for the US stock market, with the S&P 500 shedding over 43 points (3.9 percent)–its worst one-day drop in more than a year.

Catalysts for the selloff included an unexpected rise in US initial jobless claims, a seemingly unstoppable oil spill in the deepwater Gulf of Mexico and fears of a global financial crisis touched off a sovereign debt crisis in Europe. Concerns about the possibility of a double-dip recession also began to gain traction in May 2010.

In retrospect, investors overreacted to the headlines. The global economy wobbled temporarily, but growth reaccelerated by summer’s end. And although some EU countries continue to struggle with excessive debt burdens, the contagion never spread to the US corporate bond market; larger US companies continue to enjoy easy access to credit at attractive rates.

Investors’ overzealous selling in late May 2010 represented an outstanding buying opportunity for one of my favorite income-oriented groups: energy-focused master limited partnerships (MLP). Although the S&P 500 didn’t bottom until early July, the Alerian MLP Index hit its closing low of 284.89 on May 20, 2010. At the end of April 2011, the benchmark MLP index was up almost 50 percent from that nadir, handily outpacing the S&P 500’s return over the same period.

As longtime readers can attest, this history lesson isn’t a case of 20-20 hindsight. In the May 13, 2011, issue of The Energy Strategist Weekly, Buy Master Limited Partnerships Now, I explained why the correction represented a buying opportunity. My basic rationale: Investors were panicking, though business conditions for our favorite MLPs remained robust.

A year later, global markets face a similar litany of concerns and investors, once again, have overreacted in predictable fashion. The latest spate of data suggests that the US and many other developed market economies have hit at least a temporary soft patch.

Meanwhile, debt concerns in peripheral EU economies were never resolved fully, and investors are fretting about the need to restructure Greek government debt. Their biggest fear is that the sovereign debt crisis in Greece and Portugal will spread to larger EU economies–namely, Spain and Italy.

But investors are reading too much into the headlines. With the average MLP off its all-time high by more than 10 percent, this summer marks another outstanding buying opportunity. Here are three reasons why MLPs should be at the top of your shopping list.

Buy MLPs: Credit Still Strong

Access to credit is essential for MLPs. As an income-oriented security class, MLPs depend on high yields and growing distributions–the equivalent of dividends–to drive stock prices higher.  MLPs grow their payouts primarily through acquisitions or building new pipelines and other growth projects.

Both growth strategies require capital: The heavy, fixed assets MLPs own generate copious and dependable cash flows but require large up-front investments to build. And buying assets or other MLPs can be expensive, particularly in healthy market environments. MLPs generally raise capital in one of two ways: taking on debt or selling additional units (the MLP equivalent of shares).

Recent turmoil in EU sovereign credit markets has once again prompted some to worry that MLPs will face difficulties issuing new bonds or getting credit lines at favorable rates. But those fears are unfounded.

Greek two-year government bonds currently yield more than 25 percent after increasing steadily since the beginning of 2011. Despite the country’s aggressive fiscal austerity measures and a bailout from the EU and International Monetary Fund, the consensus still believes the nation’s debt burden is unsustainable and will require restructuring.

Some in Europe have floated the idea of “reprofiling” Greece’s debt, or extending the maturity of the nation’s existing bonds, giving the country more time to repay. Such a move would amount to a partial restructuring of the nation’s debt. Meanwhile, the European Central Bank appears dead set against any haircut on Greek bonds. The internal conflict in the EU over how to deal with Greece has ratcheted up the uncertainty.

As I explain in Beware the Greeks at my free blog, Greece and the EU have several options to repair the Mediterranean nation’s ailing finances. Greece could cut spending and collect tax collection to begin addressing its tax burden. In fact, the Greek government earlier this week announced that it would accelerate the sale of state assets and $8.5 billion in budget cuts.

Another possibility is that the EU continues to extend and pretend, giving Greece aid in the hope that improved economic conditions will aid fiscal restructuring. Finally, Greece may win a voluntary debt restructuring deal from its creditors to extend maturities.

These scenarios open the door for interesting opportunities in Greek bonds and equities, but the fact remains that Greece’s travails are a sideshow.  The combined gross domestic product (GDP) of Greece, Ireland and Portugal is less than USD800 billion, compared to Germany’s USD3.33 trillion GDP and France’s USD2.65 trillion.

Investors should focus on Italy. Italian public sector debt remains high, but unlike Greece and Portugal, a GDP of $2.11 trillion makes the country’s economy an important component of the EU. If the fiscal rot were to spread to Italy, the EU would suffer and the shock could spread to global credit markets. Fortunately, the news from Italy is better.

Source: Bloomberg

This graph compares the yield on a five-year Italian government bond to an equivalent five-year German bund. Germany is the largest EU country and boasts the strongest fiscal position; the higher the spread between Italian and German government bonds, the more risk is priced into the Italian sovereign bond market.  

This spread has jumped lately, but it’s still well under levels witnessed at the end of 2010 and is roughly in the range it has been in since the EU credit crisis kicked off just over one year ago. Moreover, consider that German bund yields have been depressed lately by safe-haven buying, as institutional investors seek to reduce risk.

The price of five-year credit default swaps (CDS) on Spanish and Italian government bonds is another way to gauge the perceived risk in these sovereign debt markets. CDS markets show the cost of insuring a government’s bonds against default. The higher the CDS cost, the more investors are pricing in the risk of a default or major debt restructuring.

Source: Bloomberg

Despite Standard and Poor’s recent review of Italy’s credit outlook, CDS for the nation are still near the low end of their 12-month range. Meanwhile, Spanish CDS are higher and have risen sharply of late, but remain well under the levels witnessed late in 2010.

At this point, the credit issues afflicting countries on Europe’s periphery are having a much smaller impact on Italy and other major cogs in the Continent’s economy.

These jitters in the EU sovereign debt markets have yet to spread to the US corporate bond market. In 2011 US corporations have sold nearly $640 billion worth of bonds, including more than $150 billion in high-yield (junk) bond. Through the same date in 2010, US issuers only managed to sell $453 billion in total debt and $111 billion in high-yield offerings. With $124 billion in sales and still another week to go in the month, May 2011 is on pace to rank among the best months for US corporate bond sales in 2011.

One of my favorite MLPs, rated single-B by Standard & Poor’s, issued $250 million 8-year bonds two years ago carrying an 11.75 percent coupon rate. Earlier this month, the same company issued $750 million worth of 10-year bonds at a yield of less than 6.5 percent. The MLPs we follow in MLP Profits enjoy strong access to capital and can borrow money at record-low interest rates.

The issues in the EU sovereign debt market haven’t affected US corporate bond markets.

Buy MLPs: No Obama Tax Massacre

Earlier this month, rumors of a Treasury Dept proposal that would change the taxation of MLPs prompted a broad selloff that hit units of even the best-run partnerships.

The proposal, uncovered by the National Association of Publicly Traded Partnerships (NAPTP), reportedly would call for all pass-through entities with gross receipts over $50 million to pay corporate tax. This proposal differs from prior legislation regarding partnerships and the issue of “carried interest.” If passed, the proposal would eliminate the tax advantages of the MLP structure.

Talk of a new tax on MLPs brought back unpleasant memories of the “Halloween Massacre,” the infamous day when the Canadian government announced it would modify the tax treatment of Canadian income trusts, causing a short-lived downturn for the group. One of the most common questions posed to us at the recent Las Vegas MoneyShow was if a similar overnight massacre could befall MLPs. In a word, the answer to that question is a resounding “no.” 

There can be no overnight change in the tax code governing MLPs because any tax proposal from the Obama administration or Treasury would need to be formulated into legislation and win approval in Congress. With Republicans controlling the House of Representatives and Democrats controlling the Senate, gridlock rules the day in the executive bridge. A proposal to tax MLPs has next to no chance of passing a Republican-controlled House. In fact, Rep. Dave Camp, a Michigan Republican in charge of the powerful House Ways and Means Committee, recently told The Hill newspaper, “[Taxing MLPs] isn’t something I’d be inclined to consider.” Camp’s comment suggests that any MLP tax will be dead on arrival.

In addition, such a proposal doesn’t enjoy widespread support on the Democrats’ side of the aisle either. In the past, several Democratic leaders have targeted MLPs for taxation, but most of the talk has focused on financial partnerships and private-equity funds. Prior proposals would have explicitly exempted energy-related partnerships from additional tax burdens.

Even when the Democrats controlled the House and Senate by significant margins, they were unable to pass legislation that would have taxed carried interest earned by Alliance Bernstein Holding LP (NYSE: AB) and other MLPs in the financial sector. This past failure suggests that such a proposal would stand little chance of passing, especially with the gridlock in Congress. The Obama MLP tax scare is a red herring; regard any downside in the group as a buying opportunity.

Buy MLPs: High and Rising Yields

Of course, the best reason of all to buy MLPs is that the underlying businesses are performing well. Nothing attracts income-oriented investors more than high yields and steadily increasing distributions.

Source: Bloomberg

Check out this graph, which compares the Alerian MLP Index’s historical yield to that of three real estate investment trusts (REITs), utilities and the 10-Year US Treasury.

As you can see, the yield on the benchmark Alerian MLP Index has declined steadily over the past few years, as units of the average MLP has rallied significantly since mid-2009. But the Alerian MLP Index still yields considerably more than the other income-oriented groups listed in depicted in this graph. And the recent pullback in the Alerian MLP Index has pushed the average yield for to almost 6.5 percent–the highest level this year. One of the top picks in MLP Profits’ model Portfolios now yields almost 10 percent.

That’s despite the fact the outlook for the group has never been better. In the first quarter, the typical MLP boosted its payout at the fastest pace since 2007. MLPs remain an outstanding way to play a number of key trends underway in energy markets, including booming demand for liquefied natural gas (LNG) in international markets, soaring petrochemical demand for natural gas liquids (NGLs) and the development of America’s massive oil and gas shale fields.

Your Questions Answered

I will host my next monthly chat session on May 26 at 2:00 p.m. EST. This is your opportunity to ask me any questions you might have about specific Portfolio holdings or emerging trends in the energy sector. I look forward to these online dicussions and hope you’ll be able to join me. Click here to sign up for a notification email about the chat session.