Earnings Disappoints the Markets - America's Energy Future Brightens

 Markets Sell off as Earnings Continue to Disappoint

It was a rough week for the stock markets as each attempt to establish gains quickly came to an end.  The markets could not maintain any positive momentum whatsoever even with earnings help from some key companies.  Facebook for example initially gained 22% when the company reported better then expected results.  However, by the end of the week, Facebook had given back almost half of it's post earnings gains.

The S&P 500 lost 1.5% this week and closed nears it's lows for the week at 1,411.  The S&P 500 is now down 4% from it most recent highs attained on September 14th.  However, the S&P 500 has still gained 12% in 2012 as the chart In The Photo Section illustrates:

(See Image of Chart of the S&P 500 in The Photo Section)

We are in the 4th inning of earnings season and so far the results have been disappointing.   Most companies are guiding down future earning projections in their conference calls.  Additionally, the number of companies who have failed to meet their expected revenues is the largest number since 2002.  Most businesses are expressing concern about the near term future economic conditions - which we commented on three weeks ago - and their concern of the impact of the upcoming Fiscal Cliff.

Some Good News Locally For Boeing & Housing

This week the Puget Sound received some very good news.  Boeing reported excellent earnings and a strong backlog of orders for future aircraft deliveries.  The optimistic comments from Boeing coincides with recent comments from Alcoa about strong aluminum demand from the entire aerospace industry.  Boeing's earnings reports and optimistic comments on it's future is welcome news to everyone here in the Puget Sound region as Boeing is a prime employer of 10's of thousands of people.  Furthermore, Boeing success leads to an economic multiplier effect felt throughout the region.  This multiplier effect will create new jobs and news sales for many businesses other than Boeing.  Government tax revenues will also increase each time Boeing adds people to it's payrolls.  Even non-profit agencies will benefit as donations will increase whenever Boeing employment in the region is growing.

One other earning report we would like to highlight is Pulte Homes.  Pulte Homes is one of the largest home building companies in the USA.   Below is an excerpt from Pulte's earning report that was released this week  - We believe this report from Pulte confirms our earlier thesis that the USA Housing Markets have bottomed and that prices have now begun to move higher - from the report:

.......Revenues rose 14.1% year/year to $1.3 bln vs the $1.42 bln consensus. Higher revenue for the period was driven by a 6% increase in average selling price to $279,000, combined with a 5% increase in closings to 4,418 homes. Net new orders for the third quarter totaled 4,544 homes valued at $1.3 billion, an increase of 27% and 43%, respectively, over the prior year. The year-over-year increase in signups was generated from 7% fewer communities. On a unit basis, PulteGroup's quarter-end backlog was up 49% to 7,686 homes with a value of $2.2 billion, compared with a prior year backlog of 5,143 homes with a value of $1.4 billion. The Company's third quarter 2012 backlog is the highest dollar value since the second quarter of 2008.......

So readers can have a better idea as to how well the Seattle & Eastside housing markets are performing now - In The Photo Section is a chart of New Housing Permits for Seattle - Bellevue - Tacoma for the past 25 years.

(See Image of Chart of New Housing Starts for Seattle - Bellevue areas in The Photo Section)

As you can see we have had a sharp rise in new home permits in 2012 which probably seems right with your own observations of the new projects breaking ground in your neighborhood.  Also note that the New Housing Starts are just reaching the "bottom" of their average range for the prior 25 years - so activity still has more room for growth based on historic trends.

America Finds Buried Treasure at Home in the Form of Huge New Energy Reserves

We would like use this weeks commentary to bring to readers attention a story that has been developing in the USA during the past four years.  The story is that thanks to tremendous amount of oil and gas  reserves found from the Dakota's through Ohio and Pennsylvania - America has reversed a 30 year trend of increasing dependency on Foreign Oil and we are now quite unexpectedly on the road to energy independence.

The extraction of these huge new reserves of oil & gas is made possible by the techniques known as Hydraulic Fracturing & Horizontal Drilling.

Hydraulic Fracturing is a process where millions of gallons of water, sand and chemicals are pumped underground to break apart the shale rock which will cause the release of natural gas and oil for extraction.  Suffice to say there is some environmental controversy over it's use.

Horizontal-Drilling (also known as directional drilling) is as it's name describes - Drilling is done horizontally instead of vertically.   This Horizontal Drilling technique creates access points to reservoirs of oil and  natural gas thousands of feet beneath the surface that are not otherwise  available via traditional vertical drilling.    Some estimates are that an oil or gas reservoir can yield up to 3 times the oil or gas using Horizontal Drilling as compared to the traditional vertical drilling technique.

Together - the techniques of Hydraulic Fracturing and Horizontal Drilling is resulting in America reversing it's multi-decade long growing dependence on foreign oil.  This year the USA will produce more energy domestically than at any time in it's history.

30 years ago, the USA imported approximately 28% of it's oil from foreign countries.  The amount of oil imported into the USA has increased from 28% of our annual demand in 1980 to over 60% in 2005.

However, over the past five years - thanks to the Hydraulic Fracturing and Horizontal Drilling techniques described above - the amount of oil that is imported from overseas has fallen from 60% to 40% of our total annual use. 

In The Photo Section is a 30 year chart that illustrates this lessening dependence on foreign oil thanks to the recent energy discoveries and new extraction techniques.

(See Image of Chart of USA Imports of Oil as a percent of annual use in The Photo Section)

The economic benefits of a reduction in the country's dependence on foreign oil are immense.  Think of each time an American citizen fills their gas tank.  Part of the money paid for this gas will go to the service station - some more will go to an oil company or refiners such as Chevron or Exxon and some more  to government taxes.  However the vast majority of all this money that people pay for gasoline will go to an Oil Producer residing in a foreign country (Oil is now around $87 a barrel).

So every time we put $60 worth of gas in our automobile we are virtually attaching wings to a significant portion of that $60  and watching that money fly away directly to some other country in the Middle East, Russia or Canada where their economies and people will receive the benefits instead of ours.  This is why the benefit of a reduction in dependency on foreign oil is so important for our economy - it keeps all those dollars here in the USA where the money will be recirculated to create more demand and jobs here rather than overseas and somewhere else.

The economic benefits of America's recent energy boom cannot be understated.  There has been an estimated 1.7 millions jobs created over the past 5 years from America's recent energy discoveries. It is estimated that the number of jobs created from the new energy discoveries made possible by these extraction techniques will reach 3 million by 2015.  These 3 million jobs are also good paying jobs unlike so much of the low paying service sector jobs that the economy has created over the past 12 years.   Right now unemployment in the drilling areas such as North Dakota is at 3.0%.  If you need a job or want to start a small business then head to North Dakota where the economic winds are firmly at your back.

These large reservoirs of cheap natural gas is also resulting in some manufacturing jobs returning to the USA.  Companies in the Fertilizers, Chemical & Manufacturing industries have announced over $10 Billion in investment in manufacturing plants  - many for the first time in the USA.  These manufacturing plants are expected to employ 10's of thousand of people in high paying jobs.  Needless to say this will be a very welcome condition for so many people who are unemployed or under-employed.

Finally - for everyone else - natural gas is at $3.43 a btu - the same price as it was in the 1990's.  The low cost of natural gas will help keep everyone's fuel bills low and that will free up more money for people to spend on other things - this will also be helpful to the overall economy.

We also have more good news on the energy front.  We have observed that unleaded gasoline  prices have fallen almost 10% over the past month.  The decrease in the futures price for unleaded gasoline should be arriving to your local gas station in 3-4 weeks.

In The Photo Section is a chart that shows the recent fall in the futures price of unleaded gasoline.

(See Image of Chart of The Future Price of Unleaded Gasoline in The Photo Section)

Closing Thoughts
We expect the stock markets to continue to be under selling pressure for the next few days.  However some opportunities could be arising, especially in the technology sector.  Intel for example has sold off so hard that it is now trading at a 9 PE and is offering a 4.1% dividend - much higher than any bank account or certificate of deposit.

Much of "old technology" such as Intel has been perceived to have been left behind by the shift from personal computers to mobile platforms and companies such as Intel are now putting their best efforts forward in an attempt to catch up.

As always we advise people before any investment decision is made to contact your financial advisor to determine it's suitability for you.

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John Patrick Bray, CPA, is President of Bellevue-based Reliance Investment Management LLC  a Registered Investment Advisor Firm.

This communication reflects the opinions of Reliance Investment Management LLC and is being provided for informational purposes only and is not intended as a recommendation, an offer or solicitation for the purchase or sale of any security referenced herein or investment advice. It is being provided to you on the condition that it will not form the primary basis for any investment decision.  We recommend that you consult with your investment advisor before the purchase or sale of any securities. The information contained herein is of the date referenced and Reliance Investment Management LLC does not undertake an obligation to update such information. Reliance Investment Management LLC has obtained all market prices, data and other information from sources believed to be reliable although its accuracy or completeness cannot be guaranteed. Such information is subject to change without notice. The securities mentioned herein may not be suitable for all investors.