December 2012 Market Commentary
The U.S. economy is slowly moving ahead as we approach the end of the year. The first release of third quarter G.D.P. was 2%. This was revised upward in November to 2.7%, which was slightly better than earlier thought, but still too slow to help decrease the number of people looking for work. With September being the end of the government’s fiscal year, the impact of government spending on the third quarter was very noticeable. Some estimates think this added as much as 0.6% to G.D.P. for the quarter. The portion of G.D.P. that reflects corporate capital spending has ground to a halt. Manufacturing activity in the U.S. contracted in November. The Institute Of Supply Management released its November PMI index for manufacturing. It came in below 50 which indicates a contraction. The November employment data came in about where expectations were, however, both September and October were revised lower. Companies are not going to spend until the mess in Washington is cleared up. I believe that the 4th quarter G.D.P. will come in around the 1 ½% to 2% range. However, there are areas of improvement in the world. The fastest growing economies are in the developing world. The Brookings Institution has announced thirteen of the top performing metropolitan areas for growth are in China. It also showed three fourths of the fastest growing metro areas are in Asia, Latin America, the Middle East, and Africa. Central banks around the world are still providing large amounts of liquidity to their markets.
The European Union balances on the edge and so far has managed to avert disaster. China seems to have slowed their inflation to the point that they are adding liquidity and loosening lending requirement’s to encourage growth. Their manufacturing seems to have bottomed out and is showing a slight improvement. The latest Chinese PMI was above 50 for the first time in months. Japan and Australia are also injecting funds to increase economic growth. As I have mentioned in previous Commentaries, the United States is slowing mostly from self inflicted wounds. Hopefully, the fiscal cliff will be avoided and some compromises can be achieved on taxes. The economy and the stock market, I believe, will be on hold until these problems are resolved.
However, amidst all the doom and gloom with the U.S. economy are several areas of bright sunshine. The technological developments in the oil & gas industry are revolutionizing the economy. The real stimulus has been the lower cost natural gas AND THE DRAMATIC INCREASE IN OIL PRODUCTION. This phenomenon is due to the increase in shale oil production. The shale play has increased U.S. oil production by about 25% since 2008. This is the largest increase in oil production of any nation on earth. The revolution is in the very beginning and has the ability to dramatically increase in the future. This, so far, has added one million seven hundred thousand job in an economy that desperately needed them. Not only are people working on drilling rigs, but manufacturing jobs for hardware, pipe, pumps, compressors, controls and other components have been created. This production increase could add another two million or so jobs. There is approximately $15Billion in pipe line construction under way and this does not include the Trans Canada pipeline. Exploration and Production companies are increasing their budgets even in the face of the problems coming from Washington. The increase in oil production also generates sixty two billion dollars in taxes to federal, state and local governments. It has also cut our balance of trade deficit by seventy five billion dollars in 2012. .
Natural gas prices have rebounded somewhat from the lows of below $2 per million BTUs, but are still at insufficient levels to encourage more drilling for dry gas. Currently dry gas prices are in the $3.60 per million BTU range. This price range is great for utilities, chemical companies, fertilizer manufacturers and manufacturing in general which use natural gas as a fuel or feedstock. As a result, chemical companies are continuing to move production back to the U. S. from overseas which is causing plants in the Gulf Coast to expand capacity at a strong clip. The American Chemistry Council stated that as long as natural gas liquids are poring out of wells, we will continue to have a decisive competitive advantage. The Chemical industry has responded by announcing $40 Billion in plant expansion. The lower prices are helping any industry that uses natural gas or natural gas liquids to be more competitive.
BSG&L has a long term investment horizon. We still believe industrials, including manufacturing and chemicals, are the place to be. However we are not adding to our positions until we see the market resolves some of its problems. Until we see the outcome of the fiscal cliff, it will be difficult to predict the economy, thus the markets going into 2013. However, having said that, we like chemical companies, fertilizer manufacturers, Small to Mid Cap E&P companies that are increasing reserves and production year over year and manufacturing companies. Two E&P companies we like are Continental Resources and EOG Resources. In the MLP space, we like Enterprise Products and Kinder Morgan Partners. They are less sensitive to commodity prices, since they transport, store, and process oil and natural gas without taking ownership. Until the impasse in Washington is resolved, cash is king. These two MLP companies have nice dividends and have shown an ability to increase quarterly distributions for some time. In the chemical industry, we like LyondellBasell (LBY) and Huntsman Corporation (HUN). Their profit margins have shown a greater increase due to cheaper natural gas prices than some of the bigger chemical companies.
Just to restate, I believe the European debt problem, the fiscal cliff, and the myriad of new regulations will be a damper on 2013 economic activity and therefore investment returns. Additionally, a large number of new regulations are going to be implemented in 2013. The degree and type of requirements will be the key to the economy going forward. I believe that even if there is a compromise in Washington, tax rates on dividends will go up as well as marginal rates on people with incomes over $250,000 per year. This will slow the economy and reduce capital formation. Hedging this volatility, in my opinion, will be hard. That is why we are in emphasizing investments in companies with good cash flow, good cash distributions and companies in areas that have a completive advantage due to much lower energy costs and raw material input costs. Gold last year was as volatile as the stock markets. I believe copper and oil will be the inflation hedges going forward. We prefer companies that generate good after tax returns. With interest rates at historic lows, even if dividend taxes go up your after tax returns are higher than most investment grade debt. Central Banks around the world have injected so much liquidity into their markets, that when it is put to work, commodities will move dramatically in price. BSG&L is a long term investor. We believe 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