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Investment Strategy

S&P 500 Poised to Head Higher

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

After two months of consolidation, the S&P 500 has broken out to an all-time high, supported by improving US economic data and solid first-quarter results from the index’s underlying companies.

The Institute for Supply Management’s (ISM) Purchasing Managers Index (PMI) for the manufacturing sector is one of my favorite leading indicators for the US economy.

This diffusion index is easy to interpret: PMI readings greater than 50 indicate an expansion in economic activity, while a dip to less than 50 corresponds with a contraction. Readings below 46 can presage a recession; levels of 53 or greater are consistent with solid economic growth.

Readers often ask why we focus on manufacturing PMI, when this sector accounts for only 12.5 percent of US gross domestic product (GDP).

Although the service sector dominates the US economic landscape, manufacturing serves as a canary in the coalmine; manufacturing PMI has proved its efficacy as a leading indicator that turns before the economy as a whole.

Although the ISM won’t release its May PMI numbers until next week, Markit Economics last week issued its Flash PMI estimate for May.

Source: Bloomberg

Given the directional correlation between Markit Economics’ advance estimate and the ISM’s PMI, the jump in the Flash PMI to 56.2 from 55.4 in April bodes well for the forthcoming official number and suggests the US economy has rebounded from the weather-disrupted first quarter.

All but 11 members of the S&P 500 have reported results for the first three months of 2014, with almost 53 percent topping analysts’ consensus estimates for revenue and a whopping 73.7 percent beating on the bottom line.  

Last quarter, about 61 percent of S&P 500 companies beat on the top line and almost 72 percent exceeded Wall Street’s consensus earnings estimate.

US GDP grew at an annualized rate of 0.1 percent in the first quarter, down from 2.6 percent in the fourth quarter of 2013. And when the government releases the second revision to its estimate of first-quarter GDP, the updated figure could show that a slight contraction occurred.

The coldest winter weather in two decades is behind most of the weakness in first-quarter GDP. However, the solid earnings and revenue posted by S&P 500 companies in this challenging environment should encourage investors..

Check out this graph tracking the year-over-year growth in revenue for all securities in the S&P 500.

We’ve highlighted the first-quarter data column in red. Columns to the right of this bar represent consensus analyst expectations for sales growth, and bars to the left show historical data.

Source: Bloomberg

Despite weak economic growth in the first quarter, the average S&P 500 company grew its revenue by 2.7 percent–the best year-over-year growth rate of any quarter over the past 12 months..

With growth in the US and other key economies accelerating in the second quarter, consensus expectations call for year-over-year sales growth to reach 4 percent to 5 percent by early 2015.

Bottom Line: We expect the S&P 500 to eclipse 2,000 before year-end.

How to Profit

A lackluster recovery from the 2007-09 financial crisis and recession has left the US economy without a clear engine to power growth.

Consumers hard hit by the downturn in home prices and struggling under excess debt back in 2009 buckled down and focused on repairing their balance sheets. Meanwhile, businesses remain reluctant to boost spending and invest in future growth amid an uncertain global economic environment.

Over the past year, these trends have started to fade; however, this change is still in its early innings.

In some sectors, businesses already run their assets close to maximum capacity. Take, for example, the energy patch, where US refineries operate at an extraordinarily high utilization rate to take advantage of the robust profit margins available to operators with access to discounted, domestically produced crude oil.

Last week, the Energy & Income Advisor team attended the National Association of Publicly Traded Partnerships’ (NAPTP) annual MLP investor conference at the Marriott Sawgrass Resort outside Jacksonville, Fla.

It was a grueling, but ultimately illuminating, two days of presentations and breakout sessions with senior management teams from 67 energy-focused master limited partnerships (MLP).

If you’re not familiar with these high-yielding, tax-advantaged securities, you’re missing out on one of the most compelling growth and income opportunities in the energy space.

Most MLPs own pipelines, gas-processing plants, oil terminals and other midstream assets. As production from the US shale oil and gas revolution continues to ramp up, the nation will require a massive expansion of its energy infrastructure to accommodate these volumes and transport regional and national surpluses to areas of demand.

In March 2014, the Interstate Natural Gas Association of America (INGAA) published its report on North American Midstream Infrastructure through 2035. The results of this comprehensive study are truly shocking.

The 2014 report estimates that US energy companies will need to spend $30 billion per year through 2035 on midstream infrastructure:

In 2011, the INGAA estimated that US energy firms would need to spend a total of $261 billion between 2011 and 2035 on midstream infrastructure; the organization’s most recent report has raised this estimate to $641 billion.

That’s some serious money when you consider that energy-focused MLPs have a combined market capitalization of about $500 billion.

And that’s only the midstream spending required to support growth in shale production. The INGAA study doesn’t factor in the massive investments producers will need to make to drill these wells.

Look for years of strong growth in capital spending for the midstream operators and strong gains for investors in the best-positioned MLPs.

But to invest successfully in MLPs and book mammoth returns from the surge in midstream investment you can’t just throw darts at a list of midstream MLPs.

Consider the varied performance within the Alerian MLP Index, an industry benchmark that comprises 50 popular publicly traded partnerships.

Over the past 12 months, EQT Midstream Partners LP (NYSE: EQT) has delivered a total return of more than 57 percent, while Boardwalk Pipeline Partners LP (NYSE: BWP) has plummeted by a gut-wrenching 41 percent over the past year.

You can’t afford to miss our detailed video outlining two simple tactics for investing in MLPs that have helped us generate real wealth for our subscribers over the past few years. 

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