Over the last few years, the U.S. economy has grown in fits and starts, registering a bad quarter and then returning to moderate growth in the following one.
First quarter GDP growth fell 2.9%, according to the final estimate by the Bureau of Economic Analysis. Some of this weakness is due to the extremely cold weather. As the economy slowed, yields on 10-year U.S. Treasury notes moved below 2.45%. They have since rebounded to around 2.64% as of July 3.
The turmoil in the Ukraine has eased somewhat, at least in investors’ eyes. However, oil prices are hovering around $103 per barrel for West Texas Intermediate as the unrest in Iraq roils the energy market.
Employment keeps moving ahead with the economy adding 288,000 jobs in June and the jobless rate falling to 6.1%. With job growth of 200,000 in most months, an additional 2,400,000 new jobs on an annual basis should help the expansion.
As a result, the household debt-service ratio as a percentage of after tax income is below 10%. This is the lowest level since the Federal Reserve began tracking this data. Most economists expect second quarter GDP growth in the 2.5% range. So far, Congress has not threatened to have an impasse over raising the debt ceiling or to shut down the government.
The overall optimism is aided by other positive numbers. The Institute of Supply Management’s June PMI reading came in at 56, down slightly from the previous month. Anything above 50 indicates expansion. Inventories held steady at 53.
If the economy keeps growing, manufacturers will need to add to inventories to keep pace. Other indicators also point to expansion. New car sales rose in June to a yearly average of 16.98 million units. This is the highest level since 2006. The Conference Board reported that the Leading Economic Index rose 0.5%. This is the fourth month in a row for the increase.
These are forward-looking indicators which should point to further expansion. As we finish the second quarter, rail volumes are up much stronger than previous estimates. Along the same line, an index that tracks trucking volumes reached the highest level since 2007.
In May, the International Energy Agency revised its forecast for daily oil demand upward by 1.32 million barrels to more than 94 million barrels by the end of the year.
In previous market comments, I have discussed the tremendous benefits to domestic manufacturing from lower natural gas and natural gas liquids (NGL) prices.
In mid-June at the Wall Street Journal’s CFO Network Conference, executives sounded very up beat. They felt that the economy is improving, employment is increasing and several worst-case geopolitical scenarios have not occurred.
Manufacturing is growing faster than the economy in general. We are now starting to see shortages in skilled trade positions. There are several hundred billion dollars of investment into facilities that will process and export natural gas liquids.
The worldwide trend of people moving into urban areas will boost energy demand as consumers start to demand more preserved foods that require storage. This may raise demand for U.S. natural gas and natural gas liquids as well as chemicals, plastics, and vinyl products.
LyondellBasell (LYB), a plastics and chemical producer, has received a U.S. government permit for multi-plant expansion to increase ethylene production. The $1.3 billion project will increase capacity by 1.85 billion pounds per year raising capacity by about 10%.
Another expansion project enabled Westlake Chemical Corp. (WLK) to buy Vinnolit Holdings GmbH, a German manufacturer of polyvinylchloride (PVC). This acquisition allows Westlake to expand its chlor-vinyl business and adds PVC technology to its portfolio.
Rising energy prices is translating into higher profits for the players in the Bakken and Eagle Ford shale sectors. West Texas Intermediate (WTI), as already pointed out, has broken out its trading range. The demand for refined products is increasing, causing refiners to buy more crude.
This is good news for the energy & production (E&P) companies that I follow. Summer air conditioning use is boosting demand and analysts predict supplies will be tight next winter. For these reasons, I view any pullback in stock prices of the E&P companies as a buying opportunity.
The mid-stream energy sector is adding capacity as well, given the infrastructure needs at many new shale energy finds. Pipelines, gas liquids separation facilities, fractionators, storage capacity and export terminals are being added at a rapid rate.
On June 25, the Department of Commerce ruled that Enterprise Products Partners LP (EPD) and Pioneer Natural Resources will be allowed to export slightly modified gas condensates. The condensate has been modified to remove very volatile lighter hydrocarbons and therefore qualifies as “not crude.”
EPD also announced plans to build a 1,200-mile pipeline from the Bakken to Cushing Oklahoma. This should enable more of the Bakken crude to be transported at a lower cost, increasing margins on oil produced in the Bakken. It will also free up some rail capacity to ship grain which is behind due to a lack of rail capacity.
With lower energy cost and increased demand from other global economies, the outlook for large-cap industrials is promising in my opinion. Emerson Electric (EMR), Honeywell International (HON) and United Technology (UTX) have been trading near 52-week highs in recent weeks.
United Technology has several long cycle businesses that allow them to maintain good long-term growth in share price and dividends. We also hold a position in Rockwell Automation (ROK), which has performed well on the earnings front over the last year.
I like to focus on companies with good cash flow, a strong competitive advantage and attractive price-earnings ratios. With interest rates at historic lows, even with the recent jump in dividend taxes, the after-tax returns on some stocks is higher than most investment grade debt in my opinion.
BSG&L Financial Services is a long term investor and I believe that if you are patient, build cash and buy good companies on pullbacks, your portfolio may have good growth over the long term.
DISCLAIMER: The investments discussed are held in client accounts as of June 30, 2013. 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. Past performance is no guarantee of future results.
BSG&L is a Texas-based registered investment adviser. Our founding principals, Ben Dickey and Kevin Londergan, have more than 30 years experience in both accounting and financial services.
At BSG&L, we believe that greater and consistent returns can only be achieved by identifying long-term tendencies in the investment markets and understanding fundamental shifts in expected investment returns.