December 2013 Market Commentary

The U.S. 3rd qtr. GDP growth was revised up from 2.8% to 3.6%.  Unfortunately, the final sales growth number only increased from 1.7% to 1.8%.  The majority of the increase in GDP was attributable to a larger than expected increase in inventories.  Ultimately, if final sales do not increase, retailers will need to slow their purchases in order to reduce inventories.  This would cause a slowdown or reversal of the GDP increase.  On a more positive outlook, the November employment report came in stronger than expected with new hires slightly over 200,000.  This number is not as good as it looks as almost half the new jobs were created by local, state and federal governments.  Also, the private sector jobs that were created are lower skilled or part time positions.  Wages continue to expand at a much slower pace, increasing only 0.2%.  With this slow of a growth in wages, the middle class has lost ground in terms of “real wage growth”.  Over the last six years, the inflation rate has exceeded this wage growth rate.  This lack of growth explains most of the sluggish sales performance.


There are still several bright spots within all the numbers.  U.S. factory output increased in November  for the sixth straight month.  Increasing demand from our domestic economy as well as overseas should lead to increased production into next year.  The Institute for Supply Management released its latest results showing an increase in manufacturing activity.  This most recent increase moved the index into territory not seen since the initial expansion started back in 2009.  This rise in the index is due to manufacturing companies who have announced over 120 projects  with a combined capital investment of $110 Billion.  The expansion is over many industries including chemicals, tires, steel, and others.  The major reason is the very cheap natural gas prices in the U.S.   A Dutch fertilizer company announced they will build a billion dollar plant on the Gulf Coat to produce methanol.  The only input feedstock is natural gas.  Currently the U.S. imports about 5 million tons of methanol per year.  Several other chemical companies have announced they will be restarting idle methanol plants.


Overseas economies are showing improvement.  U.S. lumber exports increased 22% year over year for the first nine months.  Over one third of this increase was due to China.  One lumber trader was quoted as saying he has not seen this strong of a demand for some time.  Energy consumption is also increasing around the world.  This is causing an increase in demand for U.S. exports of gasoline, distillate, coal, and natural gas liquids (NGL’s).  Some of the plant expansion I mentioned earlier will increase our ability to export butane, propane and even ethane.  This should increase the profitability of our domestic mid-stream companies as well as the second tier E&P companies we follow.  U.S. refiners are now shipping over 3.5 million barrels per day of refined products overseas.  We have also moved up to become the second largest oil producer in the world, passing Saudi Arabia.  Expansion of chemical plants to take advantage of lower natural gas and natural gas liquids is continuing at a rapid pace.  Currently over $100 billion in pipeline expansions and the previously mentioned chemical plant expansions will dramatically increase our export capability.  In addition, this increased activity should create a growing need for skilled labor which should add to employment and continue the growth for our domestic economy.


Our domestic energy industry continues to grow.  Several of the large mid-stream companies are expanding capacity due to the industry’s increase in Natural Gas Liquids (NGL) production.  Several of our holdings are among the leaders in this area.  Kinder Morgan Partners (KMP) and Enterprise Products Partners (EPD) are adding to their ability to transport, store and separate liquids, and the export of these products is expanding into international markets.  Another improvement in the industry is the recent rise in the oil price of West Texas Intermediate (WTI) which benefits many of the domestic E&P companies.  Due to the increase in new pipeline capacity, the increase in WTI relative to Brent pricing should continue.


This should increase the profitability of E&P companies.  With that outlook, we are adding to several of our positions in this  sector.  We continue to like EOG Resouces (EOG), Continental Resources (CLR), Oasis Petroleum (OAS), Sanchez Petroleum Corp (SN) and Whiting Petroleum (WLL).  These companies are demonstrating substantial year over year production increases and earnings growth.


In the oilfield services business, SEADRIL (SDRL) increased their dividend so that their current yield is over 8% based on improved earnings in their most recent quarter.  They have three new deep-water, floating drilling rigs being delivered from shipyards this year.  They are already under contract for several years.  Deep water drilling activity in the offshore West Africa and offshore Brazil areas should keep this company fully utilized for several more years.  The Gulf of Mexico is experiencing a nice turnaround.  The government has finally sold new leases.  The deep water rig count has been increasing and will continue to do so.


In the chemical sector, we continue to add to our holdings in LyondellBasell (LYB), Huntsman Corporation (HUN) and Westlake Chemicals (WLK).  Westlake just announced a 96% increase in earnings due to increased pricing and the much lower cost of their feedstock.  They are increasing the production of ethylene as well as their  chemical production. Based on current energy prices for oil and natural gas, we believe that energy producers, energy infrastructure companies, chemical companies and industrial manufacturing companies are the place to be.


Just to restate, I believe the economy is slowly expanding in spite of the previously mentioned problems.  That is why 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 that generate good after tax returns.  With interest rates at historic lows, even as dividend taxes go up, the after tax returns are still higher than most investment grade debt.  There is a growing shift from very low yield bonds into equity. 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