February 2016 Market Commentary

Our economy limped into 2016. The fourth quarter, estimated to come in around a plus 1.25% fell to 0.7%.  2015 was a roller coaster year with the first quarter having a loss and the second quarter was a robust 3.9% gain year over year.  The third quarter slipped to a 2% gain followed by the paltry 0.7% in the fourth quarter. For the last three years, every lackluster quarter has been followed by a strong quarter. Will this happen again?  Let’s look at several factors affecting our economy.


We have enjoyed good job growth. We added 851, 000 jobs in the fourth quarter which was the most for any quarter last year.  However, January jobs growth fell to only 151,000.  In addition, wages are now rising faster than inflation giving real spending power to the consumer.  Worker’s after tax income in the quarter rose at a 3.2% rate and January wages rose 0.5% on a year over year basis.  Since our economy is about 70% based on consumer spending this has the ability to sustain our growth at a moderate pace.  However, consumers are saving these wage increases as well as the savings from lower energy cost and using them to pay down debt.  The personal savings rate in the fourth quarter rose to 5.4%.  January consumer confidence came in positive so the savings today could supply future growth.  Even though households did their part, their positive consumer activity could not offset the fact that most industrial companies and the oil and gas sectors are in a recession.  GDP is being dragged down by an expanding trade deficit, a reduction in capital spending and a paring down of inventory.  One key measure of manufacturing health, demand for long lasting manufactured goods, fell 5.1% in December and was down 3.5% for all of 2015.  These are the largest declines since 1992.  A very strong dollar coupled with weakness in China, Brazil and Europe have hurt the American manufacturer’s ability to export.


Many pundits are focused on the fact that the profits of all S&P 5oo firms are falling and that this is a prelude to a coming recession. However, if you remove manufacturing, mining and oil & gas companies from the S&P 500 totals, profits are relatively stable.  A lot of the falloff in manufacturing is partially related to the dramatic decrease in oil and gas investment.  As with all cycles, this will end and the spending will return.  With job growth as strong as it has been and wages beginning to increase, my belief is there will not be a recession.  I believe our economy will grow at about a 2% rate this year.  When oil prices began to rise, the economy could increase its rate of growth as investment returns.


If you look hard enough there are always areas of the economy that are profitable. In the chemical industry, natural gas is both a fuel and a raw material.  The boom in shale gas and an abundant supply of natural gas liquids has enabled them to have a strong competitive advantage over other producers around the world.  Over the last few years major chemical producers have spent more than $147 Billion dollars on new plants to take advantage of inexpensive Natural Gas Liquids



(NGL’s) and these projects are starting to produce results. We are adding to our positions in

Westlake Chemicals (WLK) and LyondellBasell (LYB). LyondellBasell added 800 million pounds of ethylene capacity last year and just recently completed a major ethylene expansion at its Channelview plant and is continuing expansion work at their other plants. The gulf coast has become the largest producer of plastic resins and later this year, when the enlarged Panama Canal opens, it will be able to satisfy increased demand from Asia.  It is estimated that the exports of these products will increase more than 50% over the next two years.   We believe the pullback of these stocks is a buying opportunity for long term investors.


Another “downstream” sector that is having good margins due to the collapse in oil prices is the refining sector. Oil is their raw material and they manufacture gasoline, diesel, jet fuel, lubricants as well as other products.  The difference between the price of a barrel of oil and the price you can sell the refined products for is known as the “crack spread”.  With oil prices so low the “crack spread” has increased for refiners.  In this sector we hold Phillips Petroleum (PEX), Western Refining Co. (WHR), and Alon USA Partners (ALDW).   The entire sector is performing well.


The mid-stream sector of the oil and gas industry is another sector that we like. They have spent billions of dollars in new capacity to ship, store and export oil, natural gas liquids (NGL), refined products and semi-refined products like ethylene, and condensate.  Enterprise Products (EPD) distributable cash flow has held up very well year over year.  They enjoy a 1.3 times coverage on their dividend.  They also have several billion dollars of new projects coming on line this year.  Standard & Poor’s gives them a BBB credit rating which is investment grade.  The company has stated they intend to increase their dividend 5.1% this year.  Their cash flow is more than adequate to accomplish this.  For this reason we are adding to our position.  The other Mid-Streamer we like is Kinder Morgan (KMI).  They are also increasing capacity and are expanding their natural gas pipeline into Mexico..


Many companies that derive income from overseas have been hurt by the strong dollar. However, companies that are domestically orientated have done well.  For this reason we are adding to our positions in several companies that are showing good growth in the consumer sector.  The names we like are Kroger (KR), Walt Disney (DIS), Home Depot (HD) and Tractor Supply Company (TSCO).  These are companies that should benefit as the consumer starts to reaccelerate their spending after having paid down their debt balances.  Other companies we like are Wells Fargo (WFC) and JP Morgan (JPM) in the financial sector, as well as several pharma companies such as, Eli Lilly (LLY), Bristol-Meyers Squibb (BMY), and Steris PLC (STE).


We are not adding new money to our industrials positions at this time, but we are not selling out of them either. These companies are holding up fairly well in spite of the strong dollar.  We will continue to watch the dollar and to listen to the next quarterly reports of Honeywell (HON), United Technologies (UTX), Emerson Electric (EMR) and Rockwell Automation (ROK). These companies have been selling off, and it has been increasing their yield based on their current dividend.  This will increase the likelihood that we will began adding to our positions in the future.


We are not adding to our holdings in the Exploration and Production sector for oil and gas. Hedge Funds and traders are shorting the oil market driving down the price.  However at prices in the low $30 dollar range our production will fall.  No one is profitable at these prices so production will fall and the supply/demand imbalance will correct itself.    World demand is still increasing at about 1.5% rate.  In addition, the decline in production from existing fields is about 4 mm/day per year.  That means the world needs to find 5 to 6 mm barrels/day per year to keep production/demand in balance.  This should enable prices to climb to the $55/barrel range by year end.  As prices stabilize and began to rise this will be a buying opportunity. 


With the last two months of soft data coming in, fixed income has strengthened. The spread between the 30 yr. Treasury and the 2 year Treasury has compressed.  The Federal Reserve left interest rates unchanged in January and I believe they will also leave them unchanged in March. Hopefully this will ease pressure on the dollar and allow our currency to weaken some. We are monitoring the strength of the dollar, employment gains and the ability of Iran to begin exporting more oil. Invest in companies with an advantage due to much lower energy costs and raw material input costs.  BSG&L is a long term investor and we believe that if you are patient, build cash and buy good companies on pull backs, your portfolio will have good growth over the long term.



BSG&L Financial Services LLC