August 2014 Market Commentary
Over the last few years, our economy has suffered thru a bad quarter and then returned to moderate growth in the following quarter. The first quarter of 2014 has been revised upward to only negative 2.1%. The second quarter expanded at a more robust 4% growth rate. This is a good sign but the first half of the year is an average of less than 2% growth. Also, inventory buildup in the second quarter accounted for 1.4% of the growth. Other signs are also positive. Employment is still averaging about 200,000 hires per month, including 210,000 in July. At this rate is will take about eighteen months to reduce the underemployed or unemployed slack in the labor market. Even thought this is not robust, adding 2,400,000 new jobs annually to the payrolls should help the expansion. Additionally in the second quarter, durable goods orders which are items that last over three years, expanded as well as capital spending from businesses. On Friday August 1st, the Purchasing Managers Index was increased from 55.3 in June to 57.1 for July. Manufacturing, one of the sectors in the PMI, expanded for the 14th consecutive month. Seventeen of the eighteen sectors in the index reported gains. Respondents said orders are slowly increasing and costs were mostly flat. Also on a positive note, the Conference Board stated consumer confidence increased from 86.4 in June to 90.9 in July. This is the highest reading since prior to the recession in 2007. Offsetting these positive developments is the Labor Department release of median wages on the last day of July. On a year over year basis they reported that median wages rose only 0.8 percent for the second quarter. This is less than inflation. As has been the case for the past several years, if you take all the data, it shows the economy increasing overall at about a 2.5% rate.
As I have mentioned in previous Monthly Comments, the explosion of hydrocarbon production is giving the U. S. a dramatic advantage in manufacturing. If you take the production from the Bakken, Eagle Ford and Permian Basin together, it would be the fourth largest petroleum producer in the world, about 4,000,000 barrels per day. The U. S. is at or is passing all producers to become the world’s largest petroleum producer. A by product of oil production in the shale plays is a large amount of natural gas liquids (NGL’s). As I have discussed in the past, this is the feed stock for the chemical industry. Chemical plant expansion along the Gulf Coast is expanding at a rapid rate. Two companies we follow, LyondellBasell (LYB) and Westlake Chemicals (WLK), are experiencing very rapid growth in revenues and earnings. Both companies have billions of dollars of capital expansion underway which should lead to enhanced profits for several years. On pullbacks, we continue to add to these positions.
With rising sales prices for natural gas and NGL’s, we are seeing increased profits for the players in the Bakken and Eagle Ford shale formations. West Texas Intermediate (WTI) price has broken out of the channel that it has traded in for over twenty months. Usually the second quarter is when we see annual lows for oil prices because winter is over and the driving season has not started. However, WTI closed over $106.00/ barrel several weeks ago confirming the break out above the upper limit of the trading range. Due to geopolitical events, the markets, including oil have pulled back about 5%. This should enable buying opportunities in the near future. The demand for refined products is increasing, causing refiners to buy more crude. Our refineries are running at a very high production rate. Oil stocks are basically flat even with the increased production. This is very good news for the E&P companies we follow. Not only are oil prices holding around $100/barrel, but NGL prices are rising as well. Lastly, the amount of natural gas in storage at the end of winter was very low. Several analysts predict that we will not be able to replace all of last winter’s withdrawals, leaving us below the needed capacity for this winter. Although we have experienced cooler than normal weather in the north and east parts of the country, we are now leaving the shoulder season, where large amounts of natural gas go into storage, and are entering hotter weather which will cause utilities to increase gas usage in order to produce more electricity for air conditioning. For these reasons we view any pullback in stock prices of the E&P companies as a buying opportunity. Several names we recommend in this area are Continental Resources (CLR), EOG Resources (EOG), Oasis Petroleum (OAS) and Whiting Petroleum (WLL). For a play on the Marcellus shale, Gastar Exploration (GST) and Range Resources (RRC) are where we are putting our money. Range Resources just announced major production increases in a very BTU rich gas area with a large percent of production in NGL’s. Also, Gastar is seeing good production in their Utica leases and has expanded into oil bearing formations as well.
The mid stream sector is adding capacity as well. Most of the new shale finds are in areas that did not have a lot of infrastructure. Pipelines, gas liquids separation facilities, fractionators, storage capacity and export terminals are being added at a very rapid rate. To add to this need for expansion, the Department of Commerce ruled on June 25th that Enterprise Products Partners LP (EPD) and Pioneer Natural Resources will be allowed to export slightly modified oil condensates. The condensate has been modified by processing thru a distillation tower. Several months ago, I mentioned that some mid stream companies are adding splitters for this purpose. EPD also announced plans to build a 1,200 mile pipeline from the Bakken to Cushing, Oklahoma. This should enable more of the Bakken crude to be transported by pipeline which will lower transportation cost, thus increasing margins on oil produced in the Bakken. This should enable EPD to maintain its growth going forward.
Large cap industrials continue to maintain good growth. With lower energy cost and increased demand, they should maintain solid growth. Emerson Electric (EMR), Honeywell International (HON) and United Technology (UTX) have recently pulled back with the general market decline. If their earnings remain strong, which we anticipate they will, this should give us a very good entry point in the near future.
We are emphasizing investments 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