Author: Ben Dickey, BSG&L Financial Services LLC
Covestor models: Pure Growth and Growth Plus Income
The U.S. economic growth for the first quarter was revised down from the original 2 ¼% to 1.9%. The economy appears to be slowing at a slightly faster rate than before. Jobless claim are higher and employment gains have been smaller over the last few months.
The May employment numbers were well below consensus estimates. They also revised downward the last two monthly numbers. Oil prices have fallen about 15% over the last month, but Brent crude prices still hold a premium to West Texas Intermediate (WTI). The first of several new pipelines from Cushing, Oklahoma to the Gulf Coast refineries has begun shipping crude oil to be turned into product.
This should allow WTI prices to begin approaching Brent prices. The only reason there had been an abnormal price differential to Brent is because of all the oil in storage at Cushing. With approximately forty four million barrels of crude in storage with limited ability to ship it out, until now, the price was being bid down.
We still import about nine million barrels per day of our 15 million barrel need at Brent prices which keeps our gasoline prices high. I believe this pull-back in oil and gasoline prices is an overreaction to the European debt crisis and a slowing in the emerging market economies. I still believe oil prices for WTI will close out the year in the $100 to $110 per barrel range.
Our economy is also being buffeted by the European troubles. Investors have been focused on the sovereign-debt crisis in Europe. The markets have been concentrating on Greece, but a bigger problem is looming with Spain. The yields on Italian debt for 10 year bonds has recently spiked to around 6.15%. Spain’s 10 year debt is now approaching 5.6%.
These rates make it impossible for the struggling Southern European countries to reduce their deficits. In addition, the U.S. is facing a multitude of tax increases and government spending cuts in January. As a result, market sentiment has turned extremely pessimistic. U.S. equity markets have approached a very over-sold condition. Fear has trumped fundamentals in the market.
Oversold markets are like a tight rubber band. As fear subsides, the market will snap back. The U.S. economy is plodding along at a very slow rate, but a positive one. The fundamentals are beginning to show some correction for a few of the problems, which is encouraging. Major technological advances in the oil & gas industry have allowed the U. S. to increase their oil production for the first time in over twenty years.
A large percentage of the employment gains in the U.S. have been in the oil & gas industry. The decrease in natural gas prices is lowering the cost to manufacturing companies. Utilities, where they are able, are changing from coal to natural gas for electricity production. This should help lower utility costs, helping the U.S. economy. In addition, the increased production of natural gas liquids such as ethane, propane and butane has lowered the input costs for the chemical industry.
As a result, chemical companies are moving production back to the U. S. from overseas. Chemical plants in the Gulf Coast are expanding capacity at strong clips. This should help reduce the balance of trade deficit and add jobs.
In addition, for every one million barrels of daily output increase, our balance of trade imbalance drops by $40 billion per year. A much larger potential is the export of natural gas. Natural gas in the U.S. is trading around $2.50 per million Btu’s, however that same gas is trading around $16.00 in Asia and $13.00 in Europe.
There are several LNG projects under way for 2015 completions and the major oil companies are considering more projects. The Keystone pipeline project would also have helped our oil supply situation. Canada produces more oil than they need domestically so they are in need of an ability to export oil.
They really only have two choices. They can go West to the Pacific Ocean or South to the Gulf Coast. It is easier for them to ship oil downhill from Canada to the Gulf Coast than across the Canadian Rockies. This additional crude would have allowed our refiners to make profits on the value added by refining the heavy crude and exporting the gasoline products, thus adding employment and reducing our balance of trade even more.
Even without this pipeline, Kinder Morgan (KMP) and Enterprise Products (EPD) are expanding their current pipelines and will move more oil to our U.S refineries, thus reducing our balance of trade cost and putting people to work.
Emerging markets have slowed, but still have a growth of mid to upper single digits. China and India have doubled their economies over the last 10 years. As economies become larger, it is almost impossible to keep up double digit growth. However, an eight percent growth rate in their now trillion dollar economy is more output increase than the twelve percent growth rate that they had enjoyed over the past ten years.
In addition, China has announced plans for increased lending for expansion for local jurisdictions. This should increase their business development and may help increase their expansion back to the higher rates.
BSG&L has a long term horizon. These beliefs cause us to stay with an overweighting in our basic portfolio allocation to industrials in our Growth Portfolio. We like Caterpillar (CAT), Deere & Company (DE), Honeywell International (HON), United Technologies (UTX), Emerson Electric (EMR), and Cummins (CMI) in the industrial sector.
In the energy service sector we like Helmerich & Payne (HP), Cameron International (CAM), Halliburton (HAL), Mitcham Industries (MIND) and Schlumberger (SLB). Our commodities and energy holdings have changed very little. We continue to like Continental Resources (CLR), Anadarko Petroleum (APC) and EOG Resources (EOG) in energy.
We sold GeoResources (GEOI) since they received a buyout offer at a price that gave us a good profit for the short time we held it. In industrial commodities, we like Peabody Energy (BTU), Freeport-McMoRan Copper & Gold (FCX), Cliffs Natural Resources (CLF), Vale S.A. (VALE), and Southern Copper (SCCO).
As I stated earlier, the pipeline companies and commodity MLP’s are experiencing tremendous growth although their stock prices have not reflected that over the last few months. We think this is an excellent time to add to these positions for the even higher yields that are now available.
As a result, in our Growth and Income Portfolio we continue to add Kinder Morgan Energy Partners (KMP), Linn Energy (LINE), Enterprise Products Partners (EPD), SandRidge Mississippian Trust (SDT) and SeaDrill Limited (SDRL). These companies have good dividend rates of between 6% and 10%.
We are light in the Technology sector, but like Amazon.com (AMZN), Apple (AAPL) and International Business Machines (IBM). We have recently added Broadcom (BRCM) and Qualcomm (QCOM) to our technology holding. They are a major supplier to Apple for chips in mobile devices.
Just to restate, I believe the European debt problem and the upcoming U.S. elections have us concerned about this year. Hedging this volatility, in my opinion, will be hard. Gold last year was as volatile as the markets. Several hedge funds lost huge sums of money betting on it. I believe copper and oil will be the inflation hedges going forward.
Otherwise, the only way to reduce volatility in your portfolio is to add some consumer staples with good dividend streams. However, if you are a long term investor, the aforementioned sectors should allow an investor to outperform the markets with a somewhat reduced amount of volatility for the foreseeable future.
