The last few months have been extremely difficult for investors. The US economy has slowed in the third quarter to about 1.5% GDP growth.
In December, the US Federal Reserve began to normalize interest rates, starting with a 25 basis point hike in the Federal Funds rate.
The US dollar continues to move higher and drive oil prices lower, as well as exports of manufactured goods.
On the plus side, the US consumer is doing well, as evidenced last year in which auto manufacturers produced over 17 million cars.
Also, the December employment report came in with a robust 292,000 new jobs, higher than anticipated. This brought the total for all of 2015 to 2.6 million new jobs.
All of this positive activity could not offset the fact that most industrial companies and the oil and gas sectors are in a recession.
In the short run, these economic tremors can inflict a lot of pain in the financial markets, but historically this is a short-term phenomena.
If you go back to the depths of the 2008 financial crisis, within two years we were closing back to long-term trend lines in both the oil markets as well as in the equity markets.
In my opinion, we are close to starting this process again. Having said this, how do these historic lows affect BSG&L’s investment philosophy?
Pros and Cons
Engineers are taught that “for every action there is an equal and offsetting reaction.” As oil and natural gas prices have fallen, the producers have been hurt.
On the other hand, we as consumers have benefited greatly. Gasoline is at levels not seen for over a decade.
This helps consumers as these low prices boost their household cash flow.
Refineries and chemical manufacturers have seen a boost in their profits. In the chemical industry, natural gas is both a fuel and a raw material.
The boom in shale gas and an abundant supply of natural gas liquids has enabled them to have a strong competitive advantage over other producers around the world.
For this reason we are adding to our positions in Westlake Chemicals (WLK) and LyondellBasell (LYB).
Another “downstream” sector that is having good margins due to the collapse in oil is the refining sector.
Oil is their raw material and they manufacture gasoline, diesel, jet fuel, lubricants as well as other products.
In this sector, we hold Phillips Petroleum (PEX), Northern Tier (NTI), and Alon USA Partners (ALDW).
Domestically focused consumer companies aren’t impacted by the strong dollar.
That’s why we picked companies such as Kroger (KR), Walt Disney (DIS), Home Depot (HD) and Tractor Supply Company (TSCO).
Other consumer players on our favored list include Wells Fargo (WFC) and JPMorgan (JPM) in the financial sector, as well as several pharma companies such as Eli Lilly (LLY), Bristol-Myers Squibb (BMY), and Steris PLC (STE).
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 the next quarterly reports of Honeywell (HON), United Technologies (UTX), Emerson Electric (EMR) and Rockwell Automation (ROK).
These companies have been selling off, and it has been increasing their yield based on their current dividend.
This will increase the likelihood that we will begin adding to our positions in the future.
The fixed-income sector has sold off as well. As interest rates rise, the value of a fixed-income security will fall.
The market will reduce the price until the yield to maturity is very close to other securities in their sector.
However, the coupon is still fixed at the rate when purchased and the bond will pay par at maturity.
Unless you are afraid of default, the falling value of a fixed-income security only creates a realized loss if you sell.
If you own individual securities, not bond mutual funds, continue to clip your coupon and hold the principal until maturity.
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 at levels that are attractive compared to the low interest rates on investment grade bonds.
BSG&L is a long term investor 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.
The investments discussed are held in client accounts as of January 19, 2016. 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 that investment decisions we make in the future will be profitable.
Photo Credit: Simon Rees via Flickr Creative Commons
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.