The Dow Hits the High Notes

by Shawn Narancich, CFA Vice President of Research

Dow 14,000

The Dow Jones Industrial Average became the latest blue chip equity index to signal the success that stocks have enjoyed so far in 2013, conjuring up images of the go-go days of the late 1990s and levels markets reached in 2007 prior to the financial crisis. Whether investors will once again be punished for participating in stock ownership at levels now within a few percent of all-time highs depends in part on how successfully the global economy deals with the continued deleveraging of mature economies, and how rapidly the faster growing emerging markets can pick up the slack. So far, so good. Commentary from fourth quarter earnings reports paints a reasonably constructive outlook for profits this year, aided by low unit labor costs, a relatively benign environment for commodity costs, and potentially better demand from faster growing economies in Southeast Asia and South America. Companies are cash rich and have erred on the side of caution, returning free cash flow to investors through dividend increases and share buybacks. Capital allocation strategies could change in 2013. For companies challenged to grow earnings in a late cycle environment, the pace of acquisitions could pick up at a time of reasonably priced equities and ultra-low interest rates. 

More Than Meets the Eye

Fourth quarter GDP was shocking at first blush, portraying an economy that contracted for the first time in three and a half years. Inventories dropped and government spending fell at the fastest pact since 1973, after unusually fast spending growth reported in the third quarter. Put those factors aside and the economy as measured by real final sales actually grew by 1.1 percent in the December quarter. While the government wouldn’t speculate about the magnitude of its impact, we know that Hurricane Sandy disrupted output in the Northeast, and rebuilding in the wake of that disaster is likely to help the economy early this year. Indeed, the monthly payroll report released earlier today supports the notion that our economy is moving ahead, albeit at a relatively slow rate probably not too far from 2 percent. That payrolls expanded at a rate of 157,000 in January is less surprising than the material revisions for November and December that retroactively added 127,000 jobs. Those revisions plus several others earlier in the year lead the Bureau of Labor Statistics to conclude that the U.S. economy created a net 181,000 jobs per month last year instead of the roughly 150,000 monthly average previously reported. Contrast the oft-revised payroll data with the purchasing managers index, a data series that isn’t revised after the fact and which portrayed manufacturing expanding at a pace that picked up from levels reported at year-end.

Black Gold

Another week, another intriguing development from the U.S. oil patch. Big Oil joined the ranks of companies reporting fourth quarter earnings this week, and while the numbers out of integrated giants Royal Dutch, Exxon Mobil and Chevron left something to be desired, the earnings out of independent refiners Valero and Phillips 66 were extraordinary. An old saw in the energy business observes that investors should buy straw hats in winter. In other words, the time to buy a refining stock would be about now, when earnings and stock prices often fall due to seasonally reduced gasoline demand and plant downtime used to prepare refiners for the summer driving season. Valero turned that common logic on its head by reporting quarterly earnings that nearly matched the previous quarter’s and surpassed even the most optimistic expectations. 

Seaway_CroppedCredit Valero’s success to the U.S. oil boom. As it turns out, the glut of mid-continent crude oil that has advantaged refiners there with low cost feedstock for the past two years is now spreading to the GulfCoast, where Valero owns the majority of its refining assets.  The Seaway Pipeline (see map), which once was used to deliver imported crude oil to the Midwest, was reversed last year so that some of the Bakken Shale oil that was piling up in Cushing, Oklahoma could be delivered at a discount price to the GulfCoast, a key refining center.  As a result, neither Phillips nor Valero imported a barrel of crude oil in the December quarter, their refining margins skyrocketed, and our nation reduced its oil import bill.  Approval of the Keystone XL pipeline currently being contemplated by the federal government would not further reduce our oil import bill, but having an additional secure supply of Canadian crude oil would go a long way to promoting North American energy independence.

Our Takeaways from the Week

  •  Stocks are on a roll as safe haven Treasury bonds lose ground
  • The economy and corporate earnings continue to achieve forward progress