November 2013 Market Commentary
The U.S. economy continues to crawl along at a slow rate of GDP growth. We have seen quarterly expansions of ver low positive growth for several years now. This rate of growth is not sufficient to increase hiring. For example, September retail sales posted disappointing results even with increased promotions. Back to school sales were slower than expected. This is causing some retailers to worry about their upcoming holiday sales. On a broader scale, wages for the middle class have not kept pace with inflation for more than five years. As a result of this, consumer confidence is at the lowest point in six months. However, if you look closely, there are a few areas of growth. After years of very low interest rates banks are beginning to see a pickup from commercial real estate loans. The commercial markets for shopping centers, apartments and warehouses are seeing an increase in demand and construction. Property values are increasing and borrowers are showing an increase in willingness to borrow based on their improving credit quality. Another growth area is U.S. factories which have increased production for five straight months. The Institute for Supply Management showed the October index rising from 56.2 in September to 56.4. In a further show of manufacturing strength, last week’s Chicago Purchasing Managers index posted much higher numbers than expected. It rose to 65.9%, a 10 point jump.
I have been writing about the middle tier Exploration and Production companies for some time. They continue to show large gains in production and reserves. New statistics from the Energy Information Agency (EIA) show new drilling techniques are greatly increasing well efficiency. These operating companies are learning more and more about the shale formations and are increasing initial flow rates as well as ultimate production from each well. The EIA has labeled the Bakken in North Dakoda and the Eagle Ford in Texas as the fastest growing production formations. These two formations accounted for 75% of the monthy increase in domestic liquids production in September. The increase in production is expanding faster than the inductry has the ability to transport it. This excess has caused WTI prices to drop, causing a widening spread to Brent prices. This also happened in 2012 and early 2013 untill more shipping capacity came on line. The pipe lines and railroads will once again expand and bring prices back into equaliberium. Untill then the lower oil prices have lowered gasoline prices wich will help consumers. Even with a glut of gasoline, refiners are running wide open to produce more diesel fuel. The booming diesel fuel market in Europe is giving our refiners very good margins on the fuel exported there.
Overseas economies are showing improvement. Spain has recently emerged from two years of recession as their central bank has reported the two year recession in the Euro zones fourth largest economy ended in the third quarter with a 0.1% growth. Borrowing cost for Spain and others on the weak side of the Euro zone have fallen over the past year and the bloc saw tepid economic growth in the second quarter. A return to growth in Spain adds to the expectations that the Euro zone is also emerging and will propell it to a positive third quarter expansion. The ZEW Euro zone macroeconomic expectation index rose to a four year high of 59.1 in October. In addition, industrial production expanded slightly more than expected. Also a sudden surge in Chinese ore purchases has caused shipping rates to increase. Their imports of iron ore soared to a record 74.36 million metric tons in September. China has also increased purchases of copper leading to a 10% increase in prices. Stronger than expected third quarter factory activity is lessening fears of a slow down in China. The Chinese official Manufacturing Purchasing Managers index increased to an 18 month high in October. Stronger demand from the industrialzed world helped the Asian economies to expand.
As our economy grudgingly improves and the international markets improve, we are well positioned to supply products to the world market. Globally, energy consumption has been slow to increase during the economic slowdown. When consumption returns to historic levels, and as this demand drives prices higher, our ability to produce less expensive domestic energy will become an even larger advantage for U.S. companies. As I stated previously, our domestic production increases from tight shale plays is providing the opportunity for U. S. companies to benefit from a lower energy cost as well as lower raw material cost. The 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 about the same amount of chemical plant expansion will dramatically increase our ability for exports and the growing need for skilled labor should increase employment which should drive growth in our economy.
As I mentioned earlier, the mid-stream companies are expanding capacity. Natural Gasd Liquids (NGL) production is expanding rapidly. Serveral 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, separate Liquids, and export these products to expanding internatioinal markets. We are adding to our position in High Crush Partners (HCLP). The increases in shale well technology is using larger amounts of FRAC sand with they provide which is driving earnings increases. HCLP has a nice yield and with their acquisitions, they should be able to grow their earnings and increase their dividend.
We also spoke about energy production that is increasing at a rapid pace. We are adding to several of our positions in the E&P sector. We continue to like EOG (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 oilfiled services business, SEADRIL (SDRL) increased their dividend to over 8% and beat the streets estimates on 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 level 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). Lower energy cost has enabled manufacturing to become more competitive in world markets. We believe 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.
Ben Dickey CFP/MBA/CHFC
BSG&L Financial Services LLC