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US Economy

It’s Cold Outside: Buy the Dips

By Elliott H. Gue, on Feb. 28, 2014

Since the beginning of 2014, US economic data has softened markedly, contributing to a 6 percent correction in the S&P 500 in late January and early February.

Despite a rally in the second half of February, the S&P 500’s top-performing sectors this year are health care and utilities–defensive groups that exhibit less sensitivity to economic conditions.

But recent weakness in the US economy reflects some of the coldest winter weather in decades, a chill that should reverse with the spring thaw.

The Big Chill

Heating degree days (HDD) compare a particular day’s mean temperature to a base level of 65 degrees Fahrenheit.

For example, the temperature outside Capitalist Times’ headquarters in Alexandria, Va., on Feb. 12 averaged 25 degrees Fahrenheit, or 40 heating degree days (65 minus 25).

Higher cumulative HDDs over a particular period correspond to colder prevailing temperatures.

This graph tracks the average US heating degree days for October through January for each year since 1973, with regions that rely heavily on natural gas for heating receiving a higher weighting.

Source: Bloomberg

Within this sample, the 2013-14 winter ranks seventh in terms of cumulative HDDs and exceeds the long-term average by about 7.5 percent.

To worsen matters, the 2013-14 winter feels colder because the 2011-12 was 6 percent warmer than the long-term average and last winter was 10 percent warmer.

And the 2013-14 winter has included a number of snowstorms that curtailed economic activity in much of the Midwest and the Atlantic Seaboard, including many areas that rarely receive significant snowfall.

Snow and cold weather limit factory output, air and road travel, and sales of cars, houses, apparel and innumerable other consumer goods.

The government adjusts much of its economic data to filter out seasonal effects; for example, the US Bureau of Economic Analysis adds to auto sales in the historically slow month of January and subtracts sales during the spring and summer.

This graph tracks actual US auto sales and doesn’t include any seasonal adjustments.

Source: Bureau of Economic Analysis

In January 2014, US consumers purchased 1,008,600 light vehicles, or 12.1 million units on an annualized basis. Seasonal adjustments added more than 200,000 auto sales to the raw data, boosting the annualized number to 15.16 million units. Even with this adjustment, car sales fell short of the consensus estimate, which called for 15.7 million in seasonally adjusted sales.

Investors shouldn’t confuse this shortfall with a structural weakness in the economy or demand for automobiles; seasonal adjustments reflect historical averages, and the 2013-14 winter has been anything but average.

Moreover, US auto dealers would need to sell about 36,000 additional cars in January for the seasonally adjusted number to meet the consensus estimate. Given the severe winter weather and a seasonal adjustment of 255,000 cars sold, the shortfall of 36,000 sales shouldn’t worry investors. 

Although economists factor the weather and seasonal biases into their models, the consensus has a long history of underestimating the extent to which the weather can distort economic data.

For example, unseasonably warm weather in the first two months of 2012 led to auto sales that consistently outstripped the consensus estimate, prompting some shortsighted pundits to call for US economic growth to accelerate significantly.

However, the warm weather pulled forward auto sales that usually would have occurred in May or June. Once these effects began to fade, auto sales and other economic data began to trail the consensus estimate.

Investors should expect the opposite to occur this year: A springtime rebound in economic data could catalyze a big rally in the stock market, as consumers act on their pent-up demand for cars, houses and other items.

With the inclement weather continuing into February, don’t expect any signs of improvement in the economic data coming out in March. But by the second half of the month, weather conditions should start to improve, setting the stage for key economic indicators to surprise to the upside.

Investors should take advantage of any pullback in the broader market to add to our favorite industrial, financial and consumer-discretionary names, several of which offer exposure to resurgent car and home sales.

Subscribers to Capitalist Times Premium should consult our Wealth Builders Portfolio, which has outperformed the S&P 500 since its inception in June 2014.


Strength in US Oil and Gas Prices is Temporary

The mainstream financial media has made a big deal about surging crude-oil and natural-gas prices in North America, with some commentators opining that higher energy prices would crimp consumer demand this year.

After all, the price of West Texas Intermediate (WTI) crude oil climbed to more than $103.00 per barrel in February from less than $92.00 per barrel in January.

And natural-gas prices skyrocketed to almost $6.50 per million British thermal units (mmBtu)–the first time the fuel has fetched more than $6.00 per mmBtu in almost four years.

The invisible hand moving this market: bone-chilling temperatures and lots of snowfall.

Source: Bloomberg

Robust seasonal demand has reduced the volume of working natural gas in storage to about 750 billion cubic feet less than the five-year average for this time of year, creating the tightest market in more than a decade.

At the same time, US distillate inventories–a category that includes diesel fuel and heating oil–look poised to plunge to their lowest levels since 2005, pushing up diesel prices and dragging WTI prices higher in its wake.

In both instances, these trends represent cyclical noise, not the beginning of a sustainable recovery in North American crude-oil and natural-gas prices. The US market for these commodities remains well-supplied because of booming production prolific shale oil and gas fields.

As the surge in winter heating demand fades, rapidly increasing hydrocarbon output will refill inventories.

The futures market reinforces that the recent upsurge in natural-gas prices, though impressive, won’t have staying power

Source: Bloomberg

The blue line on this graph tracks US natural-gas futures prices one year ago, while the orange line tracks represents the current futures curve.

Although the price of natural gas for delivery over the next 12 months has increased from year-ago levels, futures prices beyond March 2015 have declined.

In other words, market participants expect the weather-induced strength in US natural-gas prices to fade over the summer and prices to return to the neighborhood of $4.00 per mmBtu by early 2015.

This retrenchment might occur even faster, as the current price environment could tempt long suffering gas producers to accelerate their drilling and completion activity this summer.

Against this backdrop, investors should continue to focus on names that stand to benefit from America’s energy advantage, a theme that I’ll discuss at length in this week’s issue of Capitalist Times Premium.

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