MORGAN STANLEY: Here are 2 alternative sources of income if you’re trying to avoid ‘lower-quality’ stocks and bonds

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• Markets may not see a repeat of last year’s strong returns on risky assets like stocks.
• Meanwhile, the yields on high-quality assets like Treasurys are historically low.
• For alternative sources of income, investors can use dividend growers and Master Limited Partnerships (MLPs), according to Morgan Stanley Wealth Management.

2017 was a spectacular year for markets. But there’s no guarantee that we’ll be talking about an encore this time next year.

Morgan Stanley’s Wealth Management unit recognizes this, and is adjusting accordingly.

“We are starting from a very different place than in 2017,” a team led by Lisa Shalett said in a note on Tuesday. “Valuations for both equities and fixed income are elevated, while late-cycle risks — particularly in the US — are rising.”

To that end, the team is advising two sources of income that are alternatives to “lower-quality bonds and equities:” stocks that have consistently grown their dividends, and Master Limited Partnerships (MLPs).

“During periods of high equity valuations, stocks that have consistently grown their dividends have outperformed,” Shalett wrote. “Furthermore, consistent dividend growers are not expensive relative to their own history, in sharp contrast to the broad equity market.”

The team did not provide any specific individual stock ideas, although the myriad of exchange-traded funds that track dividend growers might be good starting points. Goldman Sachs’ dividend-growth basket gained 24% last year, more than the S&P 500’s 19% gain.

Publicly traded limited partnerships are another attractive source of income in this market environment, Shalett said.

Considered favorites after the financial crisis, these partnerships offered tax benefits together with high yields, and were a common business structure for many of America’s oil pipelines. But the oil-price collapse that started in mid-2014 sunk MLPs because many of them had taken on too much debt.

Morgan Stanley is not counting them out just yet.

“Today, MLPs offer a yield of 750 basis points, nearly 200 bps above that of high yield bonds,” Shalett wrote.

“While some of last year’s weakness was certainly driven by fundamentals, as a result of the industry moving toward self-funding, growing commodity prices and volumes, cheap valuations, underlying credit strength, and reduced tax uncertainty suggest 2018 may offer stronger price action.”

One area the team is not so bullish on is so-called bond proxies: sectors like utilities and consumer staples known for paying consistent dividends and not closely linked to economic cycles. That’s because they can underperform the market during periods of rising interest rates, Shalett said.

Morgan Stanley