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Market Commentary August 2015

The first revision for second quarter GDP has been released.  The U.S. economy seems to have shaken off the winter pause with the economy, as measured by GDP, rising at a 2.6% annual rate in the second quarter.  Also, the first quarter has been revised from a narrow loss to a narrow gain. However, the first half’s growth rate of 1.5% is slower than last year’s first half.  In addition, wages in the second quarter grew at the slowest rate in 33 years.  The Employment Cost Index rose a modest 0.2% in the quarter after a 0.7% gain in the first quarter.  Over the last year wages and benefits grew at a 2.1% rate, marginally above inflation.  One reason for the weak wage growth is that most of the jobs are being created in health care, retail and business services.  However manufacturing added 15,000 jobs in July out of the over 200,000 jobs added.  For manufacturing, this is the largest one-month increase since late last year.  A major reason for our economy’s sluggishness is the strength of the dollar.  Our currency is stronger against virtually all major currencies.  As a result of the strong dollar, our trade imbalance for June, the latest month available, increased by 7% to $43.8 billion.  This was driven by our imports expanding and our exports declining, which slowed the growth in our economy.  The dollar has appreciated against just about all major currencies as the Greek/Euro stalemate has developed.  This strength has caused oil prices to retreat from the $58 to $62 range it traded in for about three months to the $42 range in the last week or so.  This will slow the return of hiring in the oil patch as drillers who could make money at $60, but cannot at $42.  Copper and all other commodities have fallen as well due to the strength in the dollar.  Now let’s look at some positive signs.

In the midstream sector of the energy space several more applications have been approved for the export of condensate.  This will help the drillers as well as the companies who build and operate the “Upgraders”, which take the condensate and remove other liquids, which enable them to export the fuel.  As Mexico reforms its energy sector, several pipeline companies have been approached to expand capacity to export natural gas to Mexico.  Presently Mexico has requests to import over 500,000,000 cubic feet per day.  Several midstream companies we follow are also 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).  Kinder Morgan is the 600 lb. gorilla in the space and Enterprise Products has expanded its presence in the EagleFord by acquiring EFS midstream.  They have also completed the acquisition of Oiltanking, which has added to there liquids exporting business.  In addition they sold their off shore pipeline business and are using the cash to reduce debt and fund capital expiation.  These midstream companies derive the majority of their income from fee-based services, which do not vary with community prices.  We feel these companies have been sold off in the panic over reduced oil prices.  For this reason we are adding to both Kinder Morgan and Enterprise Products.  In the downstream sector of the energy space, the refiners are showing improvement.  Refiners buy oil as their raw material and produce gasoline, jet fuel and diesel.  With cheaper oil prices, their profit, know as “Crack Spread” is improving.  The U.S. is exporting over 4,000,000 barrels of refined product per day in addition to the volumes used for domestic consumption.  Our refineries had gross inputs of over 17,000,000 barrels of oil per day over the last four weeks.  This is a record going back to 1990.  We are adding to our positions in Phillips Petroleum (PSX), Northern Tier Energy (NTI), and Alon USA Partners.

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.  Over $149 billion dollars of capital expansion are under way.  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.  This is a highly cyclical industry but the ACC sees signs of gradual strengthening as the overall world economy improves.  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 online allowing them to further reduce their unit costs.  LyondellBasell just recently completed a major ethylene expansion at its Channelview plant and is continuing the work at their other plants.  This, in part, helped them to report a 13% gain in their second quarter profit.  We are beginning to add to these positions.

In previous Market Comments we 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) and Home Depot (HD).  These are companies that will benefit as the consumer starts to reaccelerate their spending after having paid down their debt balances.  Two other companies we like are Wells Fargo (WFC) in the financial sector and Eli Lilly (LLY) 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 their next quarterly reports.  Honeywell (HON), United Technologies (UTX), Emerson Electric (EMR) and Rockwell Automation (ROK) are the ones we like.

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 and BFA are long-term investors 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.  Author: Ben Dickey, CFP/MBA/CHFC, Chairman of the Investment Committee, BSG&L Financial Services LLC.