Jan 21 2014
Fed started year 2014 with tapering long term bond purchasing. Bond market has adjusted since last year with increase in long term rates and declining bond prices. As long term interest rates start going up, funds invested abroad will start coming back home. As fed stated, if short term interest rate or real interest rate starts going up that will put upward pressure on dollar relative to other currencies. This has many consequences including decline commodity prices including gold, silver and oil. On other side increase in interest rates bring funds invested abroad back to US, that has already evident in currency value drop at developing countries like Argentina, Brazil, India, Indonesia, Turkey and Venezuela.
We don’t know how much third part of the quantitative easing helped US economy but certainly did hurt the banking industry. It kept yield curve less steep; banks had no incentive to lend their deposits. By the time Fed completes bond purchase program long term rates will go up again to historical normal yield levels which are much higher than current rates; yield curve will further steepen which is generally considered boon to banking sector.
2013 was one of the outstanding years for the stock market returns; our long term value portfolio returned 39.7% net of fee and most of the returns in the portfolio were unrealized and long term which is taxed at much lower rate. As far as 2014, we can predict economy is going to be healthier but we don’t know what general market is going to do next year, most probably higher than last year.
Many leading economic indicators are exhibiting very positive trends. Average weekly hours on private non-farm payroll are stable, unemployment insurance claims are lower, the trend in new orders for durable goods, non-defense capital goods are up trending. New residential construction is picking up, money supply is increasing and yield curve is steep, bottom line is all leading economic indicators are in upward trend. Will markets in 2014 follow the economic trend? We believe chances are high. We don’t know what year end S&P 50o is going to be but can certainly comment on couple of strong trends.
Year 2014 is going to be very remarkable for oil industry. This year, domestic production of oil and natural gas is going to be at remarkable level. Probably first time in long term our energy exports are going to be more than imports. That will add up big time into GDP growth. Glut of oil coming from Canadian Oil sands, Bakken shale and Marcellus shale is choking transport lanes. Crude Oil stock levels are at highest level at Cushing, Oklahoma keeping wide price margin between domestic West Texas intermediate (WTI) and Brent crude from Northern Sea. As we calculated average price gap in the fourth quarter of 2013 was $11.87, probably the trend will continue in the near future. We see the biggest beneficiaries are oil refineries in the Midwest such as Holly Frontier and lesser extent domestic refiners at gulf shore. Next year we see there will be either consolidation in refining industry or these refiners command higher valuations as their profit margins go up.
Another trend in 2014 is going to be higher travel costs as airline industry went through consolidation. Six major airlines became three big carriers created oligopoly market in domestic and international routes. Only competition to these big three is South west airlines in domestic front and Jet Blue at certain segments;whereas international market is vulnerable for high prices. Only option for price conscious travelers is South West Airlines and Jet Blue but they serve only selected cities. Recently South West airlines announced it is going to get into International markets, and the repeal of Wright amendment gives South West airlines right to fly direct routes from Dallas Love field to any other city. Despite huge run in last year South West may still have bright outlook next year.
Disclosure: Long on HFC and LUV.