The U.S. economy is slowly moving ahead as we approach the end of the year. The first release of third quarter G.D.P. was 2%. This was revised upward in November to 2.7%, which was slightly better than earlier thought, but still too slow to help decrease the number of people looking for work.
With September being the end of the government’s fiscal year, the impact of government spending on the third quarter was very noticeable. Some estimates think this added as much as 0.6% to G.D.P. for the quarter. The portion of G.D.P. that reflects corporate capital spending has ground to a halt.
Manufacturing activity in the U.S. contracted in November. The Institute Of Supply Management released its November PMI index for manufacturing. It came in below 50 which indicates a contraction. The November employment data came in about where expectations were, however, both September and October were revised lower.
In my opinion, companies are not going to spend until the mess in Washington is cleared up. I believe that the 4th quarter G.D.P. will come in around the 1 ½% to 2% range. However, there are areas of improvement in the world. The fastest growing economies are in the developing world.
The United States is slowing mostly from self inflicted wounds. Hopefully, the fiscal cliff will be avoided and some compromises can be achieved on taxes. The economy and the stock market, I believe, will be on hold until these problems are resolved.
However, amidst all the doom and gloom with the U.S. economy are several areas of bright sunshine. The technological developments in the oil & gas industry are revolutionizing the economy. The real stimulus has been the lower cost natural gas and the increase in oil production.
This phenomenon is due to the increase in shale oil production. The shale play has increased U.S. oil production by about 25% since 2008. The revolution is in the very beginning and has the ability to dramatically increase in the future.
There is approximately $15 billion in pipeline construction under way and this does not include the Trans Canada pipeline. Exploration and Production companies are increasing their budgets even in the face of the problems coming from Washington.
Natural gas prices have rebounded somewhat from the lows of below $2 per million BTUs, but are still at insufficient levels to encourage more drilling for dry gas. Currently dry gas prices are in the $3.60 per million BTU range.
This price range is great for utilities, chemical companies, fertilizer manufacturers and manufacturing in general which use natural gas as a fuel or feedstock. As a result, chemical companies are continuing to move production back to the U. S. from overseas which is causing plants in the Gulf Coast to expand capacity at a strong clip.
The American Chemistry Council stated that as long as natural gas liquids are pouring out of wells, we will continue to have a decisive competitive advantage. The chemical industry has responded by announcing $40 billion in plant expansion. The lower prices are helping any industry that uses natural gas or natural gas liquids to be more competitive.
BSG&L has a long term investment horizon. We still believe industrials, including manufacturing and chemicals, are the place to be. However we are not adding to our positions until we see the market resolve some of its problems. Until we see the outcome of the fiscal cliff, it will be difficult to predict the economy, thus the markets going into 2013.
However, having said that, we like chemical companies, fertilizer manufacturers, Small to mid-cap energy and production companies that are increasing reserves and production year over year and manufacturing companies.
Two companies we like are Continental Resources (CLR) and EOG Resources (EOG). In the master limited partnership space, we like Enterprise Products (EPD) and Kinder Morgan Partners (KMP). They are less sensitive to commodity prices, since they transport, store, and process oil and natural gas without taking ownership.
Until the impasse in Washington is resolved, cash is king.We believe these two MLP companies have nice dividends and have shown an ability to increase quarterly distributions for some time. In the chemical industry, we like LyondellBasell (LYB) and Huntsman Corporation (HUN). Their profit margins have shown a greater increase due to cheaper natural gas prices than some of the bigger chemical companies.
In my opinion, I believe that even if there is a compromise in Washington, tax rates on dividends will go up as well as marginal rates on people with incomes over $250,000 per year. This will slow the economy and reduce capital formation. Hedging this volatility, in my opinion, will be hard. That is why we are emphasizing investments in companies that in our opinion have good cash flow, good cash distributions and companies in areas that have a competitive advantage due to much lower energy costs and raw material input costs.
Gold last year was as volatile as the stock markets. I believe copper and oil will be the inflation hedges going forward. We prefer companies that we believe generate good after tax returns. With interest rates at historic lows, even if dividend taxes go up your after tax returns are higher than most investment grade debt.
Central Banks around the world have injected so much liquidity into their markets, that when it is put to work, commodities will move dramatically in price. BSG&L is a long term investor. We believe if you are patient, build cash and buy quality companies on pullbacks, your portfolio can experience growth over the long term.
The investments discussed are held in client accounts as of October 31, 2012. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.
Certain information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.
