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MARKET COMMENTARY NOVEMBER 2015

MARKET COMMENTARY
NOVEMBER 2015

By BEN DICKEY
Chairman of the Investment Committee

October job gains came in much higher than was anticipated. The Labor Department stated the economy added 271,000 jobs in October. In addition 12,000 jobs were added to the August- September time frame. Also average hourly earnings rose 2.5% on a year over year basis which is the best year over year gain since July of 2009. After the hesitancy to raise rates at the September Fed meeting, this will probably move the Fed to do a December rate increase. The entire treasury curve has increased in yield since this employment report. As a result of this rise, the Wall Street Journal’s Dollar Index rose to 90.42, the highest level since December 2002. As investors increase their belief that the Fed will raise rates in December, the dollar has risen to its highest level in 13 years. As I have mentioned before, as our currency rises, emerging market currencies fall. We were beginning to see a pick-up in the economy’s of emerging markets. This will probably cause them to slow their growth going forward. The European Union forecasts that as emerging market economies slow, European exports will fall, slowing their economy as well. Manufacturing orders in Europe have stalled and manufacturing growth in the U.S. has slowed to a two year low. The Institute of Supply Management’s gauge of manufacturing fell to 50.1 in October, from an already low 50.2 in September. Manufacturing has increased for 34 straight months, but these numbers indicate that we are close to stalling. One reason factory production in the U.S. is slowing is because exports shrank for the fifth straight month.

In direct opposition to these numbers, the American consumer is doing well. With average employment gains of 206,000 jobs per month and wages finally beginning to rise, the consumer is feeling more confident. Car sales are still moving at very good rates. As a result, the demand for refined fuels is increasing both here and abroad. In the down stream sector refiners are showing good profits as they have a fair spread between Brent and WTI prices which allows them to export over 4,000,000 barrels a day of refined product with very good margins. Our domestic refiners also have the advantage of being able to refine heavy sour crude in place of the more expensive light sweet crude. For these reasons we like Phillips 66 (PSX), Northern Tier Energy LP (NTI) and Alon USA Partners LP (ALDW). The last two are variable rate MLP’s, but have yields in the mid teens % range.

As I have stated many times before, the strong dollar is part of the reason for the collapse of oil prices. Oil prices have been very volatile as of late. The price fell into the high thirties per barrel, bounced back to almost fifty dollars per barrel and is in the $41 per barrel at this writing. Some of our E&P companies can be profitable near $50 per barrel as they are improving their drilling techniques by becoming more knowledgeable about the geology of their holdings. Also, service costs have come down as a result of the slower demand for that type of work. However, sufficient amounts of oil cannot be produced at these prices in order to supply the 96 to 97 million barrels per day the world demands. Production is falling in most areas and this will allow supply and demand to come back in balance. The longer oil prices stay at these low levels, the higher the price will spike when it starts to rise. As rigs are laid down and crews are laid off, the return of both will take longer. In addition, over $200 billion dollars of oil projects have been delayed. If your investment horizon is in the one to two year time frame, buy companies with strong balance sheets on pull backs. Here we like Conoco Phillips (COP), EOG (EOG), Range Resources (RRC), Concho Resources (CXO), and Contential Resources (CLR).

The mid-stream market of the oil & gas sector has been sold off without good reason. MLP’s have been hard hit. The Alerian MLP index has lost 25% so far this year, while oil prices for domestically produced product is down 11%. These companies are toll roads where the price of the commodity does not impact their earnings to the level of E&P companies are affected. These companies have also brought on line new capacity for transporting, separating, storing and exporting the various produced products. They are building new pipelines to export to Mexico as well as bringing on line several Liquefied Natural Gas export terminals starting in the first quarter of 2016. For these reasons we have added to our positions in Enterprise Products Partners (EPD), and Kinder Morgan Inc. (KMI). Their dividend coverage is very comfortable and they are able to pay for capital projects with cash flow.
In the chemical industry, natural gas is both a fuel and a raw material. The boom in shale gas and an abundant supply of natural gas liquids has enabled the chemical industry to have a strong competitive advantage over other producers around the world. The American Chemistry Counsel (ACC) believes this will enable our domestic producers to export product with very good margins. There are over $149 billion of capital expansion in 249 projects that are under way. Most of the rest of the world’s chemical plants use naphtha to make there ethylene, where due to our abundance of Ethane which is a natural gas liquid, our input costs using ethane are much less. The U.S. chemical industry reported a 4% gain in chemical production year over year for 2014. The ACC is projecting a year over year gain of 3.2% in 2015 and 3.0% in 2016. There is a lot of chemical usage in the automotive and construction industries. 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 unit costs. LyondellBasell added 800 million pounds of ethylene capacity last year and just recently completed a major ethylene expansion at is Channelview plant and is continuing expansion work at their other plants. This helped them to report a 13% gain in their second quarter profit compared to prior year. Westlake Chemical recently increased its dividend and has maintained 44 consecutive quarters of paying a dividend. They also reported a 40% higher profit in the second quarter on a year over year basis. .

In previous Market Comment’s I have 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 Tractor Supply Company (TSCO). These are companies that will benefit as the consumer starts to reaccelerate their spending after having paid down their debt balances. Other companies we like are Wells Fargo (WFC) in the financial sector and Eli Lilly (LLY) and Bristol-Meyers Squibb (BMY) in the pharmaceutical sector.

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 the next quarterly reports of Honeywell (HON), United Technologies (UTX), Emerson Electric (EMR) and Rockwell Automation (ROK).

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, we believe 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