Wednesday, February 24, 2010

Natural Gas Outlook ala Credit Suisse

With such focus in our region of SW Pennsylvania on the Marcellus Shale I include here a brief blurb about the investment bank, Credit Suisse view on natural gas over the next year.

Oil & Gas, Exploration and Production J. Wolff

Q4'09 U.S. Gas Production Showing Up 0.4% Qtr/Qtr

Supply Stabilizes in Q4'09. With 90%+ of our quarterly gas survey now complete, we find that U.S. gas production rose 0.4% qtr/qtr and 1.7% yr/yr.

Recent supply numbers continue to surprise the market in their resiliency given shut-ins in
October and a rig count that was down 51% yr/yr in November. Clearly, we have an incomplete data set that excludes private producers. However, we think our survey is a fairly close proxy. In fact, recent 914 data for November (which is a more exhaustive data set) shows that Lower 48 supply is less than 1% off its peak in February 2009.

Look for Muted Gas Prices. With supply now stabilizing, LNG imports likely to move higher in Q2'10 and drilling activity on the rise, we would look for fairly muted gas prices through 2010. Front-month gas now trades below $5.00 per MMBtu but may find some stability given that coal price parity is close to $5.00 per MMBtu. Our NYMEX outlook remains $5.25 per
MMBtu for 2010 and $6.50 per MMBtu for 2011.

Drilling Activity on the Rise, E&Ps Set to Grow 7% in 2010. The theme from year-end conference calls continues to be rising drilling activity focused on horizontal shale/tight gas plays. In fact, since the July trough the natural gas rig count has risen 34% to 893 from 665. Perhaps more importantly, the horizontal rig count has reached a new high, surging 77% from a
372 rig trough in June to 658 currently. We estimate that independent E&P natural gas production for our coverage universe (16.8 Bcf/d in 2010) is set to grow 6.6% in 2010.

John Barnyak
Stonehouse Asset Management

Monday, February 22, 2010

Parsing the Unemployment Headlines

Each month, even each week, the financial markets focus on the release of unemployment numbers. Lately each week we again see the nascent green shoots of recovery--don't we? There is no denying that fear had abated in the past year. Corporate earning by the standards of last year are improved. But how much of the breathless optimism is real and how much overblown?

The focus on weekly statistics is largely misplaced. Of course weekly improvement is a precursor to monthly and annual improvements, but the statistical noise and revisions make the number misguiding and volatile. Currently the 4 week moving average of new claims for unemployment is 468,000 which normally means about 80,000 in new monthly job losses. Better, but more indicative of an economy in stabilization than recovery. The temporary surge in census bureau employment should also be considered as less than sustainable employment gains.

What concerns me about the employment outlook is how the various pieces of the puzzle fit (or don't fit) together.

Recently the unemployment percentage fell back below 10%. However the employment number fell more indicating that the participation rate has fallen to the lowest level in a quarter century.
The exodus of discouraged workers from the labor force is unprecedented. The growth of the number employed is lagging the population growth badly. To use this statistical legerdemain to present an improving employment outlook is beyond suspect. If the participation rate were the same as it was in 2000, the unemployment rate would be closer to 13% instead of 10%. Additionally, the share of employed persons who are working full time has also dropped 3% which would accurately reflect an unemployment rate in the mid-teens, not slightly below 10%.

At a time when the economy is weak and government policies are subject to intense scrutiny and discussion, obvious diddling of the numbers does not increase one's faith in the leadership.

John Barnyak
Stonehouse Asset Management

Tuesday, February 9, 2010

Things I Have Learned

When powerful forces have vested interests take advice with a grain of salt (if it hasn't all been used on roads around the eastern US this week.)

About six years ago, a client asked what I thought about General Motors bonds. I recall saying they weren't trading very well, but why ask me when others, like Moody's was spending millions on the answer. The bond rating agencies were telling the world things weren't as bad as they appeared.

A year ago, a friend told me she was thinking of buying National City Bank stock. The branch manager and senior management of the bank said the price was far too low and they were one of the best capitalized banks in the country. About a month later, they ceased to exist as PNC bought them before they had to declare bankruptcy.

Whenever we begin a discussion with, "people a lot smarter than I am...." it's a fair bet that those smart people are wrong. The graph above has to put your teeth in edge as words and the market diverged. In the words of Deep Throat in All the President's Men during the Nixon debacle said repeatedly, "follow the money."

When oil was at $150 dollars a barrel, the more Goldman Sachs publicly said it was going to $200 the more convinced I was that we would see $80 before $200.

The Attorney General is suing Bank of America for fraud in the purchase of Merrill Lynch as the state of Merrill was withheld from shareholders.

So trust common sense in your investment dealings. If you can't pay attention, hire someone to pay attention for you, but never give up a healthy portion of skepticism. Even if you're talking to yourself.

John Barnyak
Stonehouse Asset Management

Friday, February 5, 2010

Snow is Falling!!, Sell Snow!!

Years ago a New Yorker magazine cartoon showed a trader with a phone in each ear looking out the window and yelling, "Snow is falling, sell, sell, sell!"

This is the same urgency one is fed by the likes of CNBC where entertainment is the product, not investing. The markets have fallen a little more than 7% in the past two weeks. That is hardly spirit crushing in a market that rose more than 60% during last year. Or seen another way, a market that is exactly where it was sixteen months ago.....or where it was ten years ago. A year ago, the stock market was where it was thirteen years before. In other words, in the legendary words of Foghorn Leghorn, "Two nothings is nothing! That's mathematics, son! ... Two half nothings is a whole nothing!"

I continue to be of the belief that 2009 was a bear market rally. That view has not been without pain as a too conservative position for clients faded the previous outperformance of portfolios. But our style is risk averse and steady as clients look for long term security more than fleeting short term gains.

The principal caveat that keeps at the forefront of our thinking is the unprecedented employment picture. While in a typical post WWII recession, 24 months after the recession began the economy would be showing +100k monthly gains in employment. This morning the Bureau of Labor Statistics printed a -20k for January.

What particularly keeps me on edge is that in the face of fewer employed, the unemployment rate fell from 10% to 9.7. This fact means yet again the denominator has dropped. The work force continues to contract as longer term unemployed fall of the statistical radar screen and those discouraged and not looking are also not included.

To be sure there is good news in the employment report. The index of aggregate hours worked rose to 33.3hrs per week from 33.2, modest but positive. Backing up to look at the larger demographic picture we find that the number of employed at 129.5 million is exactly where it was in 1999, while the working age population has grown 29 million. 29 million more people competing for the same number of jobs as a decade ago.

Put this in the context of a government policy that held interest rates at zero, injected $2.2 trillion into the economy and incurred deficit fiscal stimulus of 10% of GDP. All that and employment fell nearly 5 million. Mind numbing.

The 2009 Jolt Cola technical rally is about to meet the 2010 technical reality check. The rebound of 50% of the 2007-2009 slide could well see a 50% retrenchment of that rally which would take the dow easily down another 1000 points. At that point the market will have shaken off some of its overvaluation and we would begin to get constructive again.

John Barnyak
Stonehouse Asset Management

Thursday, February 4, 2010

Weak Technicals

Equity indices are losing a technical battle as the S&P has substantially dropped below its 50 day moving average and out of the upward channel established since last March lows. The market has reached an oversold daily condition, but weekly and monthly indicators are still elevated making me suspect short term choppiness at best with a resolution downward.

The past 10 months have been government quadruple espresso as liquidity was created out of thin air in the public and quasi public sector. They are running out of Red Bull the market could give back some more of that binge.

Fundamentally until the employment conditions improve I don't know how to get excited about the market at high valuations. In an economy that is largely consumer dominated the chart below is no all-clear signal.

Click on image to increase size.

Neither employment nor average hourly wages lead one to believe inflation is just around the corner or that the Fed will raise interest rates soon.

John Barnyak
Stonehouse Asset Management

Yet Another Indicator

We all tend to pontificate a bit more than we need to, but who can resist? But this morning's industry data release from the Distilled Spirits Council of the United States, seems to sum it up perfectly. Americans are drinking more but spending less. Quantity is trumping quality in today's economy. Who says you can't have it both ways?!

John Barnyak
Stonehouse Asset Management

Tuesday, February 2, 2010

Happy Groundhog Day

Punxutawny Phil knows its not different. Same thing, different year, and yet the masses are hopeful.

"Our immersion in the details of crises that have arisen over the past eight centuries and in data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that 'this time is different.' That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy."

- This Time is Different (Carmen M. Reinhart and Kenneth Rogoff)

The Reinhart/Rogoff book is one of the stars of the financial books published in 2009 and for students of markets and history it is a good, if at times weighty, read. Much of what we presume to be conventional wisdom is in fact thinking constrained by our relatively short term experience. Reinhart and Rogoff looked back over hundreds of years to find parallels and the McKinsey Group found 32 examples of financial crisis followed by sustained deleveraging such as we are experiencing now. At a time of such uncertainty we are well advised to look at events from 30,000 feet and not from within the maelstrom.

Looking at centuries of debt cycles the Reinhart/Rogoff book reports that on average a country's outstanding debt nearly doubles within three years of the crisis. Unemployment rates on average increase seven percentage points and remain elevated for five years. Finally, once a nation's public debt exceed 90% of GDP economic growth slows by 1%.

Many of the historic models and forecasts being touted this year are based on post WW-II experience which may turn out to be less than useless, even harmful. Trillions of dollars of financial espresso can get the consumer pretty jacked. It doesn't mean necessary that it is sustaining.

Instead of econometric models of the past 40 years an analysis must look for examples, sometimes centuries old for relevant examples of deleveraging economies. Ironically the assets that look less risky now are in the developing nations. That is also where the growth is likely to be found, where the consumer sector is still very young, where national debt levels are low, where reserves are high and trade surpluses abound. The developed world has lost its position as drivers of the global economy.

Each of the developed markets presents its own challenges for investors in both equities and bonds. Japan has its aging population and need for external financing. The U.S. has large deficits and exploding entitlements on the horizon, and Europe faces such disparate members one wonders how it will remain united. Germany the extreme saver and producer while at the other end Spain and Greece are awash with debt.

It's never different, but you may need to be the better part of 100 years old to remember when it looked like this.

John Barnyak
Stonehouse Asset Managment