January 2014 Market Commentary
Last year was a bifurcated year for investors. The market was up substantially while the economy had fits and starts. The first half of the year was slow with substandard growth. The third quarter was much stronger although a large portion of the growth was due to an increase in inventory. The fourth quarter slowed. Estimates are for growth in GDP to be in the 1.75% range for this quarter. Underneath the headline numbers however there is data pointing to an increase in GDP output. A pickup in business investment and healthy new home sales are indicators of a stronger economy. Expectations are being raised for stronger output in 2014 after manufacturing and construction data showed increases in December. Factory output remained very close to the November highs as Americans are buying more automobiles, homes, appliances, furniture and other manufactured goods. The Institute for Supply Management (ISM) released its December index which stood at 57, down from a very high 57.3 in November. Any thing above 50 shows an increase in manufacturing activity. Inside this index, a measure of new orders rose to 63.6. This is the largest increase since April of 2011. Hours worked in manufacturing also increased to 42/week. This is usually a precursor to further hiring. Construction spending also increased at a 1% rate Refinery utilization rates inched up to 92.7% reflecting strong demand for refined products. U.S fuel consumption increased in November to the highest level in six years. Total deliveries for petroleum products increased by 4.9% from a year earlier, up to 19.4 million barrels per day. All of these items indicate a gathering strength in the economy.
Overseas economies are showing improvement. For the first time in over four years, Europe is showing a slight gain in output, Japan is growing and China is maintaining its approximate 7.5% growth rate. U.S. lumber exports increased 22% year over year for the first nine months 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). U. S. refiners are exporting over 3 ¾ million barrels of refined product per day. Some of the plant expansion I have been mentioning in past comments will grow 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. 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 their export of these products is expanding into international markets. There have been several joint ventures to combine the ability to export NGL liquids, primarily Butane and Propane with the mid stream companies who separate and transport this product. In the next year or so there will be a very large increase in our ability to export NGL liquids.
Over the last year, I have mentioned several times the large competitive advantage that lower energy prices have given U. S. manufacturers. The low natural gas prices have turned the U. S. into a magnet for methanol production because the primary feed stock for the manufacture of methanol is natural gas. Over the last ten years, most methanol production had moved overseas. Now that situation is starting to reverse since there are currently nine major plant expansions or new builds under way in the U.S. One of the companies we follow, LyondellBasell has restarted a plant that had been mothballed for over nine years. Celanese has just received federal approval to add a large methanol plant in its current chemical facility in the Houston area. German and Dutch companies are moving production from Europe to the Gulf Coast due to much lower raw material cost and electricity costs. This activity in methanol is in addition to the tremendous advantage cheap ethane prices are giving to the more traditional chemical manufacturers.
As we enter 2014 there are several sectors of the domestic economy that should have an advantage over the rest of the world. As worldwide economic demand increases, American industries should have an advantage. One of the largest areas for growth should be the chemical industry. 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, and industrial manufacturing companies are the place to be. The energy producers we are following are EOG (EOG), Continental Resources (CLR), Oasis (OAS), and Whiting Petroleum (WLL) which are mid tier companies that should show nice gains going forward. For the energy infrastructure arena we currently like deep water drillers with new fleets which are seeing nice gains in their day rates as well as new long term contracts. For this reason we are adding to our position in SeaDrill (SDRL) which now has a dividend in excess of 9%. We also like the traditional service companies Schlumberger (SLB) and Halliburton (HAL) should also show nice gains over the next few years. In the manufacturing sector we are adding to our positions in Honeywell (HON), United Technology (UTX), and Emerson Electric (EMR) as well as adding a new position in Dorman Products (DORM). They are a supplier to the automobile industry and are seeing nice gains in their business.
I believe the economy is expanding at a slightly faster pace than in the past. 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 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