March 2015 Market Commentary
The U S economy is expanding, but at a sluggish pace. The latest revision to forth quarter GDP lowered the gain to 2.2%. Exports were lower due to sluggish expansion overseas plus King Dollar has reduced our competitiveness for exports as the US Dollar hit an eleven year high against the Euro Additionally, productivity is expanding at a rate not seen since the 1970’s and businesses are adding capital at a very slow pace. GDP growth is determined by two factors, growth in the labor force and productivity growth. The labor force participation rate has dropped to a level not seen for several decades. Combined with lower capital spending our GDP is growing, but at a moderate rate. This current year is starting off more positive with the better than expected job growth in February, we added 295,000 jobs. This increase adds pressure on the Federal Reserve to increase interest rates. I still believe they should hold off because of the strength of our currency. The European Central Bank begins its purchases of sovereign bonds this Monday, lowering their interest rates. Along with this move there are signs their economy is slowly improving. A weaker currency and lower oil prices is beginning to help Europe’s economy improve. For the first time since 2007, the European Commission expects every country in the European zone to show positive economic growth this year. In addition, the Indian government has implemented changes to improve their economic performance and their growth is forecast to exceed that of China for the first time in decades. China’s grow is slowing, but to a still reasonable 7% range. These two most populist countries in the world will create demand for materials, energy, food, and many other items.
As I have discussed before, I believe the United States is the “cleanest dirty shirt in the laundry”. Our economy is growing, but as stated earlier, at a slower rate than normal for this stage of a recovery. However, there are signs that this recovery may be adding steam. Lower gasoline prices and pay increases that are now exceeding inflation are beginning to show up in consumer’s pockets. So far, consumers seem to be using this new cash to pay down debt and to increase spending in areas such as home improvement, entertainment, and better quality of groceries. The University of Michigan lowered its consumer confidence figure this month to 95.4 from 98.1 in January. This is probably due to the much colder weather in February. Also 95.4 is not a bad number. Last week the Institute for Supply Management lowered its top line purchasing manager’s index from 53.5 in January to 52.9 in February. Over half of this drop can be attributed to the West Coast port slow down. This should rebound as this is resolved. Also any number above 50 still indicates expansion.
As I mentioned earlier the strong dollar has contributed to the dramatic fall in the price of oil. However, oil prices seem to have stabilized somewhat. Oil closed just below $50/barrel Friday. WTI prices have traded in a narrow range around $50 for several weeks since the bottom in the mid $44 range. Baker Hughes announced that 64 more rigs were idled last week. The domestic onshore rig count has dropped for 13 straight weeks and now shows 922 rigs are working. This is a drop of over 43% since the high.in October. However oil production is staying relatively constant. Producers have concentrated their efforts in their better leases and are becoming more efficient at producing oil per well. Their greater efficiency is allowing them to stay profitable even at these prices. I had mentioned in previous Market Comments that a perfect storm had occurred and political instability in some sensitive areas had not decreased oil production. As history has shown, this cannot last forever. ISIS sponsored thugs have attacked the larger of the oil fields in Libya reducing output. Also terrorist have made some strides in Nigeria. Along with this inevitable drop in world wide production, The International Energy Agency (IEA) has announced an increase in consumption. The last reason I believe we will see higher oil prices is due to the fact that our refineries are operating at less than 85% of their capacity at the current time. There are two reasons for this. First, several of the larger refineries are on strike as labor negotiates for higher wages. Second, this is the time of year that refineries shut down to change over to their summer blend. This change to summer blends does not allow them to blend Natural Gas Liquids (NGL). As the strike is settled and the changeover is completed the increase demand from the refineries will add to the consumption side of the equation. Because we believe that prices will rise sooner than later, we are beginning to add to our positions in 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 NGL’s will increase.
The mid stream sector was hard hit as oil prices fell. 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).
Earlier in the commentary I mentioned consumers were changing their spending habits for the better. For this reason we have added several companies that are showing good growth in the consumer sector. We have added Kroger (KR), Walt Disney (DIS), and Home Depot (HD) to our list of favorite positions. These are companies that will benefit as the lower gas prices and higher wages flow thru to the consumer.
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), Rockwell Automation (ROK), Westlake Chemicals (WLK), and LyondellBasell (LYB) are the names we like here.
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