The chart below shows the performance of different sectors of the equity market so far this year. Of course, there are always sectors that are outperforming, so nothing much new there. However, if in general as an investor you don’t commit much to health care and you are overweight energy, recent months have likely given you reason to examine comparative performance rather more closely, as we have. If in addition you’ve had a couple of small positions in smaller energy names, you’ve also experienced first hand the relative underperformance of small cap stocks versus the market. Suffice it to say that the results of owning a handful of large health care stocks and being short a smattering of small energy stocks would have been about as perfect a position to hold over the last three months.

The chart tells the story, but to put numbers on it, while the S&P500 is +14% this year, Healthcare (defined as XLV, the sector ETF) has returned almost double at +27% while Energy is -19%. A good portion of the Health Care/Energy relative performance has occurred just in the past three months (28%). Interestingly, the daily returns of MLPs have been most highly correlated with Energy (64%), even though MLPs have outperformed Energy by a whopping 19.5%. In fact, at +11% for the year the performance of MLPs is not far short of the S&P500.  What’s happened is that bigger than typical daily falls in Energy spill over to MLPs even though midstream energy infrastructure (what most MLPs are engaged in) has a very different risk profile from Exploration and Production. So on days when XLE fell 1%, the correlation with MLPs was higher than normal, at 76%. MLPs react to sudden moves, but on the days when Energy is not down 1% or more (84% of the time this year) they react to their own economics.

So what does one conclude? The surprise of the past 2-3 years has been that ACA (The Affordable Care Act, or “Obamacare”) has been very good for the health care sector. I doubt many architects of that legislation expected to create such wealth for health care providers. However, the major news story of 2014 is clearly Oil. Small energy sector servicers have been extremely weak, while the economics for many energy infrastructure businesses have remained sound notwithstanding big drops in some of their customers’ stock prices. Friday was such a day. with the Energy sector -6.3% and MLPs -5.3%. There are substantial crosscurrents beneath the simply headline result of the S&P500.

Harold Hamm, CEO of Continental Resources (CLR), has most recently been in the news because of his $995 million divorce settlement, which his wife is appealing. Far more interesting though, was Continental’s recent decision to remove all of its hedges on future oil production. Closing out the short positions in oil futures generated a one-time $433 million gain, while of course also leaving the company exposed to further drops in oil prices. However, CLR also cut back its planned 2015 capex budget from $5.2 billion to $4.6 billion. This highlighted the optionality that E&P companies possess, in that within limits they can decide not to produce oil from certain fields if prices aren’t sufficiently attractive. In those cases, rather than being long oil they have a position that looks more like a long call option on oil. As option traders will readily recognize, a long oil call option combined with a short oil position (through the hedges they had) creates a long put option on oil. In effect, CLR’s ownership of oil producing assets combined with its hedges has acted in part like a put option on oil. Harold Hamm said that they believe oil has to rise in price, and that’s a good enough reason to remove the hedges. But if they’re wrong, they can at least mitigate the situation by producing less. If you’re long options, a volatile market is usually good (it increases the potential value of your position). CLR is making full use of the volatility in oil by trading their effective long put option on oil. Harold Hamm’s divorce reminded me of someone who was just going through his third. Harold probably won’t see the humor in this at present, but this serial divorcer I’m thinking of had names for his three ex-wives: Half, Quarter and Eighth, denoting approximately what he was left with following each event in the unfortunate sequence.

There has been plenty of concern recently that the drop in oil prices would cause many domestic E&P names in the U.S. to curtail their activities at marginal plays. This in turn would have a knock-on effect on oil servicers and the MLPs that manage and build energy infrastructure needed to exploit America’s shale boom. Several MLPs recently commented that they felt current oil prices wouldn’t have much impact on U.S. production. For example, Enterprise Products’ (EPD) CEO Michael Creel said, “Our analysis shows that most if not all of the core drilling area in key oil plays such as the Eagle Ford, Permian and Bakken are profitable at numbers below where we are today and U.S. drilling is certainly not grinding to a hault.”

In fact, the marginal producer of crude oil looks very much like an offshore producer.

Transocean (RIG) is an industry leader in the ownership and operation of offshore drilling rigs. In their quarterly earnings call this morning, CEO Steve Newman said,

“The market pause we began discussing with you more than a year ago has evolved into a cyclical downturn. Although our customers take a decidedly long-term view in making investment decisions, the approximately 27% decline in oil prices observed over the last three months is likely to increase their challenge to improve short-term returns to their shareholders.

In turn, this may temporarily exacerbate the offshore rig supply and balance that has already resulted in dayrate and utilization pressures and an increase in the inter-contract idle time in stacking of rigs and potentially delay the cynical recovery.”

In addition, their just filed 10Q included the following:

Goodwill—Subsequent to September 30, 2014, market conditions have continued to deteriorate, and we identified additional adverse trends, including continued declines of the market value of our stock and that of other industry participants, declines in oil and natural gas prices, the cancellation or suspension of drilling contracts, the permanent retirement of certain drilling units in the industry and increasingly unfavorable changes to actual and anticipated market conditions.  On that basis, in the three months ending December 31, 2014, we expect to reevaluate whether the fair value of our reporting unit has again fallen below its carrying amount, which could result in us recognizing additional, potentially significant, losses on impairment of goodwill.

So while lower oil prices may well hurt providers of services and infrastructure globally, it looks as if the most immediate pain is being felt in areas away from U.S. shale plays.

I was struck the other day by some of the commentary on Seeking Alpha surrounding American Realty Capital Properties (ARCP). ARCP is a REIT. Their chairman is Nick Schorsch, who is also chairman of American Realty Capital which is built around the origination and distribution of non-traded Real Estate Investment Trusts (REITs). While conventional, publicly traded REITS have their place in an investor’s portfolio, the non-traded variety represent a far more dubious sector.

In February I wrote about a non-traded REIT,  Inland American Realty (not managed by ARCP). Like many others,it’s a great investment for brokers, but far worse for their hapless clients. It includes features such as 15% of your investment as fees up front, additional fees for buying and managing properties, incentive fees and myriad conflicts of interest, in addition to which you can’t sell it because it’s not publicly listed. Foregoing a public listing is sensible if you’d rather not invite the attention of sell-side research analysts to the egregious fees you charge buyers of your product. No public listing means no trading, so no commissions and not much point in writing about it if you work for a sell-side research firm.

This is of course all disclosed, and therefore quite legal. American Realty Capital is the largest manager of non-traded REITs, with a portfolio of $30BN in assets. But the growth of the industry speaks more to the power of high fees to induce some brokers whose clients’ interests lie substantially below their own to push such products. It’s hard to conceive how anybody associated with an investment that starts life pocketing 15% of your money could in good conscience claim to be helping you grow your savings.

So now we turn to the recent news on ARCP, which is that it is being investigated by the SEC for knowingly mis-stating its financials. Two employees have resigned because they apparently concealed the mis-statement. Their bonuses were set to be higher with the higher figures.

The stock has fallen 40% since the disclosure, as the company has announced that 2013 financial statements previously issued could no longer be relied upon. Some investors wonder publicly whether to hold or sell, seeking to balance what they perceive as the good versus what is reported to be the bad in their comments.

And yet, ARCP is headed by someone who has built a business by selling  securities through ethically-challenged, fee-hungry intermediaries with little regard for the reasonableness of the resulting economics for their clients. ARCP is not American Realty Capital (their confusingly similar names initially confused me as well) but if a company’s tone is set at the top,  ARCP is run by someone who clearly cares more about fee generation that the interests of his clients.

It reminds me of Bernie Madoff. Many of his investors believed that his persistently attractive and steady investment returns were derived from the ability of his hedge fund to front-run the orders of its brokerage clients. Harry Markopolos reports that this was so in his terrific book on Madoff’s scam, No One Would Listen. As hedge fund investors, they thought they were the passive beneficiaries of such illegal behavior. They believed they incurred no risk, and probably expected that if the front-running behavior was detected, the authorities would simply punish Bernie Madoff but not his investors. They were perfectly fine investing with someone that they knew to be dishonest, reasoning that the dishonesty was directed at unwitting others and that their crooked investment manager was honest with them. Such tortured logic delivered its own type of just reward when the truth revealed no such profitable front running activity at all, delivering large losses to the gullible.

The analogy of ARCP with Bernie Madoff is not perfect, but the non-traded REIT business is not an area that reflects well on the people who traffic in them.  It’s not a nice business. ARCP investors should look carefully at the people with whom they’re invested.

Seasonal patterns to the returns of most asset classes rarely seem to last beyond their discovery. “Sell in May and Go Away” has been shown to either work or not work depending on precisely when you close the trade out. Rather than the Summer being a bad time for stocks it’s just that September is poor. Whether that’s for some reason or just random is unclear. As so often in statistics, correlation doesn’t mean causality. One month of the year has to be the worst one during which to be invested in stocks. Since 1960 it’s been September. In 2014 September was poor but January was, unusually, worse. There was no January effect this year. September’s poor record could just be random, absent any compelling explanation.

Master Limited Partnerships (MLPs) have a more pronounced seasonal effect, and it’s likely for good reason (i.e. correlation with causation). It turns out that December and January together have generated 36% of the return on the Alerian MLP Index since 1996 (whereas if monthly returns didn’t vary you’d expect only 17%, or 2/12). The reason is probably that retail investors, who tend to predominate among MLP investors, apply long term consideration to their portfolios around year-end. This can be because year-end bonuses alter their net worth and asset allocation, because it’s the end of the tax year or simply because doing the analysis provides a break from all that family time that comes with the holidays.

In any event, we’re heading into a period of time where the seasonals would suggest that, if you’re considering making an MLP investment over the next six months, committing capital in November may well produce a better result than waiting until February. Naturally, there are always the non-seasonal factors to consider and the volatility in energy-related stocks could understandably give anyone pause. The most recent Saudi news that they’ve cut prices for U.S. buyers so as to protect market share looks like a direct aim at North American unconventional production, and is likely to send another wave of worry through related equities.

Midstream MLP companies that have reported earnings in recent days appear sanguine about current oil prices and their effect on their businesses. If you own a pipeline, storage facilities or a gathering and processing network you care most about volumes rather than the value of the product you’re handling. It’ll take some time to see how that plays out in reported profits for the sector. In the meantime, news reports may continue to pressure everything energy related. If the recent pressure on MLPs turns out to be due to misplaced concern that their profits will suffer along with E&P names who have direct commodity price exposure, then returns over the next few months could be good.