April 2015 Market Commentary
First quarter GDP growth seems to be following a several year trend. The economy is having a hard time generating any momentum. The last revision to the fourth qtr. GDP was unchanged at a 2.2% annual growth rate. Preliminary estimates of first qtr. growth have been revised down to 1% or lower. It is remotely possible that we could actually have negative growth. Several indicators are pointing to a slower growth path. The rising prices on U.S. treasuries indicate that investors believe the economy is slowing and the Federal Reserve will hold off on raising rates. In addition, March’s employment number came in at a paltry 126,000 hires. The Labor Department also reduced the hires initial estimate for January and February. In conjunction with the reduced hiring, the participation rate is down to a 30 year low. Closely watched reports of consumer spending, manufacturing output and capital spending also showed declines. There are several causes for the fall in output. As I have mentioned previously, King Dollar has contributed to the slowing. The fall in oil prices was the first impact of the strong dollar. Going forward, the strong dollar is slowing exports and reducing earnings growth in companies that derive a large percentage of their revenue overseas. For all of the S&P 500 companies, 40% of their revenue is from overseas. The dollar has expanded 12% against the EURO year to date in 2015 and 27% in the last 12 months. As an indication of just how much the manufacturing sector had been impacted, the Institute for Supply Management (ISM) released its latest report which showed manufacturing fell to 51.6 from 52.9 in February. This was the 5th straight month of decline. Even worse, the employment index, a component of the larger index, fell to 50. This means there were no net manufacturing hires in March. However, as I often state, if you look hard enough you can see some positive indications.
The ISM constructs an index for manufacturing as well as one for services. The services index was just released today and it showed a minor reduction from 56.9 in February to 56.6 in March. The only component that was down was consumer spending. Consumers are saving, or reducing debt, both of which bode well for future spending. As winter weather leaves consumer spending should began to increase. As investors have seen the U.S. economy slowing and the European economy showing signs of a modest increase, they have started pulling money out of dollars and have purchased EUROs. The last item which should help the economy is the West Coast shipping strike seems to be close to ending. Some retail and manufacturing slowness was due to the reduction of imports and exports across the West Coast docks.
Since the end of the last quarter the Euro has strengthened from an exchange rate of 104 up to 108. This action seems to have put a floor under oil prices. Another event helping oil is that demand for refined petroleum products is increasing world wide. Our refineries are about finished with their spring turnaround and are adding about 125,000 barrels a day of production each week. By May these refiners should be back to consuming sufficient oil which should begin to reduce the amount in storage. Because we believe that prices will rise sooner than later, we are beginning to add to our positions in energy. We are staying with companies that have strong balance sheets and are not over leveraged. In this arena we like Linn Energy (LINE), EOG Resources (EOG), ConocoPhillips (COP) and Concho Resources (CXO). These are very efficient producers who are profitable at today’s prices and will be even more profitable as prices rise. For natural gas, we like Gastar (GST) and Range Resources (RRC). These producers are profitable at today’s prices and as the chemical industry’s new plant construction comes on line this year and next year the price these companies receive for natural gas liquids (NGL’s) will increase.
The mid stream sector has stabilized some what from the initial over reaction to the fall in oil prices. These companies derive most of their income from fee based revenue through their pipelines and NGL processing. They are largely shielded from the price of the hydrocarbon. Several mid stream companies we follow are building capacity to take advantage of the domestic expansion in production and demand in the NGL space. Our two favorite names in this space are Enterprise Products Partners (EPD) and Kinder Morgan (KMI). These companies are adding pipelines to export natural gas to Mexico as well as to export condensate and NGL’s. These projects should keep their revenues increasing as they move forward.
Earlier in this Market Comment I mentioned companies that derive income from overseas have been hurt. 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), and Home Depot (HD). These are companies that will benefit as the consumer starts to reaccelerate their spending after having paid down their debt balances.
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 their next quarterly reports. Honeywell (HON), United Technologies (UTX), Emerson Electric (EMR) and Rockwell Automation (ROK) are the ones we like. Westlake Chemicals (WLK) and LyondellBasell (LYB) are showing good profit gains on a year over year basis. Their capital expansion projects are beginning to come on line allowing them to further reduce their costs. We are looking closely at adding to these positions.
We are monitoring the strength of the dollar, employment gains and the ability of Iran to begin exporting more oil. As the world’s economy grows, the imbalance in oil will reverse and prices will return to more normal levels. Stay invested in companies with good cash flow, good cash distributions and companies that operate in areas where they have a competitive advantage due to much lower energy costs and raw material input costs. We prefer companies with price earnings ratios that are at levels that are attractive compared to the low interest rates on investment grade bonds. 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.
Ben Dickey CFP/MBA/CHFC
BSG&L Financial Services LLC