May 2015 Market Commentary
First quarter GDP growth seems to be following a several year trend. The economy is having a hard time generating any momentum. The last revision to the fourth qtr. GDP was unchanged at a 2.2% annual growth rate. Preliminary estimates of first qtr. growth were released at a dismal 0.2% growth. This will be revised down to a loss of -0.5% or worse. Imports were higher than first estimate and exports were lower. The weather, the strong dollar, the west coast port strike and estimates of slower world growth have all contributed to this performance. March’s employment number came in at a paltry 126,000 hires. The Labor Department also reduced the hires initial estimate for January and February. Another indicator that signals slow growth, the closely watched reports of manufacturing output and capital spending, also showed declines as well. The fall in oil prices has caused exploration and production companies to drastically reduce capital spending. This filters down to the industries that support oil and gas drilling. Over the last few years, the majority of capital spending for the total economy had been in drilling and industries that consume hydrocarbons such as chemicals and refining.
Over the last several years we have experienced a very week first quarter and an increase in growth in the second and third quarters. For the first time in several quarters we are seeing acceleration in real wage growth. The median income quartiles have not seen real wage growth since the recession ended. The employment cost -index rose a seasonally adjusted 0.7% in the first quarter, rising above the 0.5% increase in last year’s fourth quarter. This is the strongest growth since the third quarter of 2008. When wages rise, consumer spending has an increased ability to grow as well. The Commerce Department announced March consumer spending increased at a 0.4% rate. This is the largest increase since last August and followed three months of below average spending. In addition, the Labor Department announced April’s employment gains @ 228,000. This may show we are back on track to increase economic growth in coming quarters.
The United States was the primary engine driving world growth. There are now signs that Europe is beginning to expand. Several weeks ago the International Monetary Fund revised upward its estimate for European growth to 1.5% for this year and 1.6% for next year. In addition, the European Purchasing Managers Index pointed to a solid start for manufacturing. The growth is not isolated to Germany. Ireland and Spain are forecast to grow at a faster rate than Germany with Spain forecast to grow at a 3% growth rate this year. As the European Union begins to grow, the EURO has strengthened against the dollar. This will lessen the strength of the dollar which should help our exports.
As the dollar pulls back, commodities in general are showing signs of life. Copper, oil and agricultural commodities are showing signs of price increases. One of the largest purchases of sugar occurred last week causing the price of sugar to increase sharply. I feel that this indicates a belief that the world economy is going to grow faster than previously thought and commodity traders do not want to be caught short. In addition to the weaker dollar, another event helping oil is that demand for refined petroleum products is increasing world wide. Our refineries are finished with their spring turnaround and are adding about 125,000 barrels a day of production each week. Last week our refineries ran at over 93% capacity. By the end of May these refiners should be back to consuming sufficient oil which should begin to reduce the amount in storage. Last week we saw the first draw down of oil in storage. The heaviest period of refined product consumption occurs between Memorial Day and Labor Day. With oil production beginning to decline and consumption ramping up, we should see oil prices stabilize between $60.00 per barrel and $65.00 per barrel. The producers that we currently own will be profitable at this price. Because we believe that prices should stabilize, we are beginning to add to our positions in energy. We are staying with companies that have strong balance sheets and are not over leveraged. In this arena we like 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 natural gas liquids (NGL’s) will increase.
The mid stream sector has stabilized some what from the initial over reaction to the fall in oil prices. 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). These companies are adding pipelines to export natural gas to Mexico as well as to export condensate and NGL’s. These projects should keep their revenues increasing as they move forward.
Earlier in this Market Comment I mentioned companies that derive income from overseas have been hurt by the strong dollar. However, companies that are domestically orientated have done well. For this reason we are adding to our positions in several companies that are showing good growth in the consumer sector. The names we like are Kroger (KR), Walt Disney (DIS), Home Depot (HD) and Whirlpool (WHR).. These are companies that will benefit as the consumer starts to reaccelerate their spending after having paid down their debt balances.
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) and Rockwell Automation (ROK) are the ones we like. Westlake Chemicals (WLK) and LyondellBasell (LYB) are showing good profit gains on a year over year basis. Their capital expansion projects are beginning to come on line allowing them to further reduce their costs. We are looking closely at adding to these positions.
We are monitoring the strength of the dollar, employment gains and the ability of Iran to begin exporting more oil. As the world’s economy grows, the imbalance in oil will reverse and prices will return to more normal levels. Stay invested 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