September 2013 Market Commentary

The U.S. economy is expanding in fits and starts, but at least it is moving in the right direction.  The first estimate of second quarter GDP came in at 1.7% which was slightly lower than the 2% guestimate. The first revision to second quarter spending was raised to 2.2%, but a large part of the increase was due to increases in business inventory.  This will slow if consumption does not pick up.  The other factor in the upward revision was growth in exports.  This is a positive sign and reflects earlier projections of U.S. manufacturers increasing activity.  This is supported by the latest Chicago Business Barometer (PMI) which showed an increase of 0.5, up to 53.0.  Any reading over 50 indicates a growing manufacturing environment.  This expansion is a reflection of new orders coming in fast enough to increase backlog in manufacturing.  Offsetting this manufacturing growth is the most recent Labor Departments release of income data that showed stagnant wage growth with a majority of the increase in hours worked coming from the addition of part time jobs instead of full time.  For our economy to expand past the 1.5% to 2.0% range, wage rates must increase or more full time jobs need to be created.  Four years into the recovery, U.S. worker’s pay is not keeping pace with inflation. The average non government, non supervisory employee’s wages, when adjusted for inflation, has fallen 0.9% since the end of the recession.  This overall drop in purchasing power has slowed the purchase of durable goods. The only exception to this seems to be automobiles.  U.S. auto production has climbed to a 16,000,000 unit annual rate.  The average age of the American auto fleet is over nine years old.  This should enable auto makers to keep up this production rate for the near future. This puts the Federal Reserve between a rock and a hard place.  There is a growing shift toward tapering the Federal Reserve’s bond purchase program.  I do not believe the small employment gains or the sluggish growth in the economy warrant tapering at this time.  However positive the Fed’s bond purchase program has been for the U.S. economy, it has also caused economic problems for the emerging market economies.


The emerging markets are suffering in the summer heat, or more accurately the political turmoil in the Middle East and the prospects of a tapering of the bond purchase program by the Federal Reserve.  Both the Indian and Turkish currencies hit record lows against the U.S. Dollar in the last half of August.  The Middle East turmoil has pushed oil prices to a two year high.  Oil is priced in U.S. dollars, so as the emerging market currencies fall they must pay even more to purchase oil.  This is slowing their economies.  Oil prices should pull back once the Syrian situation is resolved.  However, the emerging markets still have a problem with the Federal Reserve plans for tapering.  The MSCI Emerging Market index incurred a 12% sell off when Ben Bernanke first indicated on May 22nd that the Federal Reserve could start tapering this year. For example, India is the world’s second most populace country and Asia’s third biggest economy. India has relied on foreign capital to fund its trade deficit.  Any slowdown in this money stream will further slow an economy that has already slowed from 6.2% to 5% year over year.  This slowdown does not signal a collapse.  The emerging markets are still expanding, just at a slower rate. The only country in the emerging market that had an increase in growth year over year was Korea.  As a bonus, Europe has finally moved from a four year recession to a small gain in the most recent quarter.  If Europe’s growth can continue, this should help the Emerging Markets to increase exports and hopefully strengthen their currencies.


What does this mean for The United States?  We are well positioned to provide many of the items that will be needed as the world’s economy begins to grow.  The U.S. Energy Information Administration stated that they expect world wide energy consumption to increase steadily for the next 30 years.  This would increase oil consumption from the present 92 million barrels per day to approximately 150 million barrels per day.  This last week, the International Energy Agency stated they believe oil consumption will increase about one million barrels per day between 2013 and 2014.  Prior to the recession, world demand was increasing about three million barrels per day on a year over year basis.  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.  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.  Expansion of chemical plants to take advantage of lower natural gas and natural gas liquids is continuing at a rapid pace.  Industrial companies have also grown rapidly over the last year.  With their advantage in the cost of energy, this growth should continue.


With the recent market correction, we have been adding to several of our positions. Honeywell (HON), United Technology (UTX), Emerson Electric (EMR) and Rockwell Automation (ROC) have all shown good year over year earnings growth as well as increased share prices.  Yields on MLPs have increased since the market selloff, with their stock prices down but their distributions being maintained.  Due to these 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.  In the E&P sector, we continue to like EOG (EOG), Continental Resources (CLR), Oasis Petroleum (OAS) and Whiting Petroleum (WLL).  Several of these have had very large year over year increases in production on top of the increased commodity prices.  We have added to these positions as WTI continues to stay above $100.00/barrel. 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).  There are over $40Billion in expansion projects to add capacity on the Gulf take advantage of the low natural gas and natural gas liquids in the U.S.. We also still like industrial commodity companies but we are not buying any of them currently.  As the world economy begins to expand again, material producers like Cliffs Natural Resources (CLF), Freeport McMoran Copper & Gold (FCX) and the larger coal companies will once again move up in the investment placement arena. However, wait until you see copper, iron ore and coal prices increase before doing any buying of these stocks.


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.




BSG&L Financial Services LLC