As the glow fades from
holiday festivities and New Year’s celebrations the view forward in 2015 is now
becoming clear, more of the same. Sounds boring but when you consider
what the returns from the prior four years were, I’ll take, “more of the same”
any day, month and year.
Where we are and our
outlook.
GDP. The US economy likely finished out the
calendar year 2014 with a 2 5/8%-2 ¾% annual growth rate if fourth quarter
growth comes in the expected 3%-3 ½% range rate of expansion. After a
surprise weather related contraction in the first quarter the economy bounced
back strongly reflecting increasing underlying strength which topped out at 5%
in the third quarter. We anticipate the trend to continue into 2015 with
growth for the year finally topping 3% annualized growth driven by strong
consumer demand and an uptick in capital expenditures.
Leading Economic
Indicators (LEI)-LEI increased to
+.6% in November pointing to a continuation of the “much of the same”.
This should portend a continuation of an improving growth trend.
Novembers release followed Octobers +6% and +.8% in September. Economist
Ken Goldstein of the Conference Board noted the LEI signals moderate growth
that is somewhat restrained by income growth. Real income growth is up
+.8% year over year.
Industrial Production
(IP)-IP jumped +1.3% in November year
over year. IP has grown +5.2%, the best showing since 2011. The
gains were led by automobile manufacturing which popped +5.1%. Ex-auto’s
IP still had a solid showing of +.9%. Capacity Utilization tightened up
with the increased manufacturing demand to 80.1% or +.8% the best since
2010. The excess factory capacity present throughout this current
recovery has been sopped up so any continued strength may finally spark the
inflation rate closer to the Federal Reserve’s target range.
Inflation- Still no problems on this front. The Federal
Reserve will just have to wait as the plunge in commodity prices in general and
specifically oil and energy related products continue to put downward pressure
on all inflation indices. Great news for consumers and commercial
users of these feedstock’s.
Employment. Job creation once again turned in a solid
showing. In 2014 Non-Farm payrolls averaged better than 240,000 on a
monthly basis, ex-Decembers figures (due out this coming Friday). The
prior three month average for the September to November period clocked in an
even better rate of 270,000 adds with November scoring the strongest
gains of 321,000. We look for Friday’s Non-Farm figure to come in right around
trend growth of 240,000.00. At the same time weekly unemployment claims
have been anchored under 300,000 for some time signaling more workers finding
new jobs. Both very positive signals. We’d still like to see the
participation rate tick up along with a decline in the population now receiving
disability checks. This program’s rolls ticked up strongly as many unemployed
individuals applied for disability benefits once ultra-long term unemployment
benefits expired.
Institute for Supply
Management Manufacturing (ISMM)-ISMM
closed out the year in December with a reading of +55.5% down -3.2% from
November but solidly above the 50 breakeven line. That overall trend was
seen throughout the report with New Orders and Production solidly over 50 but
down over 5% from the November figures. The two brightest spots were the
Employment Index rising +1.9% to +56.8% while the Price Index dropped 6% to 38
½% indicating lower raw materials pricing. Eleven of the eighteen
reporting industries reported growth. We heard from the Food
and Beverage sectors that “sales are much improved year over year”.
From transportation, “trucks and RV business very strong”. While
Fabricated Metals and Textiles noted “the ongoing drag from the West
coast port planned union slowdowns”.
Monetary Policy- The Federal Reserve has telegraphed their plans to
investors of their wanting to begin to normalize rates. Current
expectations are for the first ¼% point rate hike to occur mid to late second
quarter. This normalization plan is fluid, flexible and data dependent
with an eye to both domestic and global growth data points. Federal
Reserve Chair Yellen’s plan may be pushed back even further should the
Euro-zone and Japan slip back into recession as the effects may wash up on US
shores.
White Condors
1.
The Grid.
The US electricity grid is hit by terrorists. The US grid stretches over
160,000 miles and is easily accessible and lightly if not at all guarded.
Earlier on in 2014, April to be exact a coordinated group of attackers
cut telephone cables and snipers took out 17 large transformers that funneled
power to Silicon Valley. The country has 2000 of these type transformers
and a limited supply of manufacturers that could replace them in a timely
fashion should there be a large scale attack. Strategically coordinated
attacks on our grid could leave vast swaths of the US dark and without power
for weeks and would be catastrophic.
2.
Russia. In a complete rebuke to western sanctions
Russia mounts a full scale invasion of Ukraine in the first of an all-out
effort to recreate a smaller more compact USSR while expanding its buffer zone
to the West. Russia over the last few years has taken a page from
the Obama playbook and pivoted east towards China. As the West
tightens the economic noose on Russia with sanctions and oil prices for which
the Russian economy relies on for over 50% of total revenues continue in a free
fall Russia has turned to China. They have cultivated a wary friendship
with a very willing buyer of its natural gas and oil and diversified their
customer base making them less reliant on Europe. As Russia moves away
from Europe and closer to China they may feel emboldened to do as they wish
retaking what Putin believes is theirs from the beginning.
3.
Oil. What is the correct price of oil? Energy
“experts” rolled out the Peak Oil thesis for decades in order to justify
exorbitant pricing. Chevron’s CEO earlier this year stated “$100.00
per barrel of oil was the new $20.00”. Another noted oil expert, Harold
Hamm founder of Continental Resources was so positive of oils lofty pricing he
sold off his hedges back in the October, November months when oil was still
hovering around $80.00 a barrel confident oil pricing would rebound sharply.
Now with oil changing hands closer to $52.00 and the “experts”
claims that US producers would turn off the spigots once we broke $75 clearly a
miscalculation at a minimum why does this rate as a White Condor? The
last time speculators were chased from the markets was during the near
financial collapse and ensuing recession. The price of oil hit right
around $36.00 a barrel. We could be headed there or lower. The
Saudi’s claim they are profitable extracting oil at $10.00 Exxon says they can
extract oil profitably at $14.00. Ultimately oil pricing will be determined
when demand catches up to supply. On the supply side the US alone is
expected produce an additional 1 million barrels this year. We’ll also
see new supplies come online from Mexico, Brazil, Australia and Canada.
As well, as the outside world lifts sanctions on Iran we could see even
more production from Iran and from the middle east. These supplies
could be soaked up easily. First the Euro-zone would need to resume a growth
trajectory. Second China’s economy could cease the planned downward
trajectory it is currently on. Third India could and should continue on
its path of opening markets, engagement and encouraging foreign
investment. If oil plumbs the levels mentioned above the high yield
market could take a major hit from Exploration and Production companies that
overleveraged their balance sheets to acquire land and expand anticipating
stable or higher energy pricing. The defaults could spike rather
significantly forcing liquidations and bankruptcies while spilling over into the
equity markets as well.
Going Forward
Enough can’t be said about
the stimulative effects on the consumer and economy from the falling energy
prices. If oil prices stabilized around current levels it is estimated to
provide over $150 billion back in consumers’ pockets and that’s just talking
gasoline. Or in D.C speak $1.5 trillion since they seem to like
extrapolating out 10 years. Aside from the tax break effect consumers
will feel, inflations flames driven by commodities should be extinguished
giving the Federal Reserve a longer leash and allow slower implementation of
their interest rate hike plans. Further cheap energy feed stocks are
attracting foreign manufacturing dollars to invest in and build new plants
domestically.
The US economy has clearly reached
escape velocity from the negative gravitational pull of the bruising
recession. The US economy is anticipated to expand at a 3%-3 ¼%
pace of growth with a backdrop of low inflation and a still highly
accommodative Federal Reserve along with Global Central banks. With
corporate balance sheets and consumers ledgers in excellent shape to support
growth we look to future revenues, earnings, multiples and valuations for our
projections. We also note the potential upside surprise should our fearless leadership
in D.C finally decide to work together on tax reform. We look for
the S&P 500 companies to generate $133 in earnings this year.
Utilizing a still reasonable 16 ½% P/E we arrive at 2194 or +6 5/8% add in the
dividend yield and we come to a +8.8% total return. Due to the
sharp drop in oil and commodities along with a potential rate hike, volatility
should spike and remain at elevated levels making 2015 a challenging
year. But we believe and maintain that any correction can and should be
bought.
For now we remain
aggressively committed to the market closely monitoring data along with any
signs to change course in which case we’ll be in contact immediately.
Thank you again for your
patience and confidence in this very challenging investing environment.
Yours in pursuit of the KWAN!
