October 2013 Market Commentary
The Federal Reserve surprised the financial markets by not tapering at the September meeting. They also announced that future consideration would be data dependent. This is a cloaked way of saying “We will tapper when we want to”. With the possibility of a government shut down and a very sluggish economy, I believe they are afraid to stop buying bonds. August durable and capital goods orders were released last week. Durable goods ex-transportation (Boeing) saw a decline. This is troubling because August auto sales were strong. The latest revision to second quarter GDP was unchanged @ 2.5%. Most economists are forecasting a 1.5% to 1.8% growth rate for GDP for the third quarter. With a 1.8% rate for the first qtr. 2.5% for the second qtr. and the possibility of 1.8% for the third, the U.S. economy is close to stall speed. However, having said all this, there are always bright spots. Home prices are still climbing. The recent rise in interest rates has slowed the rate of growth in housing, but has not derailed it. Energy prices are still relatively low and manufacturing and energy companies are adding highly paid personnel. U.S. crude production rose 20.3% year over year in August. Year over year increases have been higher for 23 straight months. North Dakota production reached a record 891,000 barrels per day in August. Production in the lower fourth eight states reached the highest level in thirty five years. However, Alaska production is at the lowest in thirty seven years.
Overseas there are improvements. Spain has recently emerged from two years of recession. 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. Also in August, China’s initial reading of the purchasing manager’s index rose to 51.2 from 50.9 last month. In Germany, Angela Merkel won re-election by a large margin. This should allow the financial policies she has introduced to stay in place. A sudden surge in Chinese ore purchases has caused shipping rates to increase. The Baltic Dry-Bulk Index is at a17 month high. There is also a rise in industrial commodity prices as China absorbs some of the stockpiles. An increased appetite for steel and other building supplies is adding to the evidence of an economic rebound. China has also increased their purchases of industrial equipment.
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 have more than offset the decline in other producing areas. The proliferation of energy production 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. is now producing more oil than it imports. 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 is dramatically increasing our ability to produce exports and need for increased employment should help improve the economy. In addition, industrial companies have also grown rapidly over the last year. With their advantage in the cost of energy, this growth should continue.
Some of the industrial company names are Honeywell (HON), United Technology (UTX), Emerson Electric (EMR) and Rockwell Automation (ROC). Each of these companies have shown good year over year earnings growth as well as increased share prices. We have also added Whirlpool (WHR) to our industrial mix.
As a result of the interest rate scare from the Federal Reserve, several of our MLP’s have sold off. This is enabling us to increase our positions. Due to these lower prices, which cause increased yields, we have added to our positions in Kinder Morgan Partners (KMP) and Enterprise Products Partners (EPD). We have also added High Crush Partners (HCLP) to our mix. HCLP has a yield of over 9% and with their recent acquisitions they should be able to increase their dividend.
As I previously mentioned, energy production 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) and Whiting Petroleum (WLL). These companies are demonstrating substantial year over year production increases. As I have mentioned before, with added shipping capacity, West Texas Intermediate (WTI) prices have narrowed the gap to Brent and these companies are showing large gains in earnings. We have also added a pure play on the Eagle Ford shale formation, Sanchez Petroleum Corp (SN). They are dramatically increasing their production.
In their most recent quarterly report, SEADRIL (SDRL) increased their dividend to over 8% and beat the streets estimates on earnings. 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 U.S. Gulf of Mexico, offshore West Africa and offshore Brazil should keep this company fully utilized for several more years.
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 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