October 8, 2000
Dow Jones Average: 10,597
S&P 500 Index: 1,409
Energy Crunch
Modern society can be defined in large measure by energy consumption.
Economically developed regions such as the United States use large amounts
of energy per capita, while less developed nations use far less. Fossil
fuels, i.e., oil, natural gas, and coal are still the predominant sources
of energy used by the world. Over the past one hundred years dramatic
increases in energy consumption have been met by vigorous exploration
and extraction programs.
In spite of the long term price stability of oil, many consumers believe
that oil and gas prices are out of control. Recent price spikes in heating
oil and gasoline have alarmed consumers throughout Europe and the United
States. Protesters in England have blocked roads, paralyzing the country.
In the United States energy prices have become a major issue in the
presidential race. The reality is that energy prices are high only when
compared to the ridiculously low prices that prevailed over the past
fifteen years. At the national average of 1.54 per gallon, the price
of gasoline is exactly the same as it was in the 1950's after accounting
for inflation. And as the President of OPEC pointed out, a gallon of
gasoline is much cheaper than a gallon of milk or a gallon of Coca-Cola.
It is shocking that a dwindling natural resource so critical to modern
civilization would be priced so low. It won't always be that way.
Even though OPEC is vilified by many westerners, the cartel strives
to maintain oil price stability. Leading OPEC producers such has Saudi
Arabia, Kuwait, and the United Arab Emirates have small populations
and one natural resource, oil. These countries want the world to remain
dependent on oil, so they try hard to meet world demand at prices that
undercut competing energy sources. They do not want to encourage the
development of alternative energy sources until their oil fields are
nearly exhausted.
It is apparent that the world can not move to a higher level of economic
growth without putting strains on the energy supply/demand balance.
Energy consumption continues to rise in the United States, thanks in
part to more gas guzzling cars and trucks on the road. The increase
in energy usage is even more dramatic in emerging economies that are
rapidly industrializing. Newly developed economies in Asia, South America,
and Eastern Europe are the swing factor in worldwide energy consumption.
When these economies were growing in 1997, energy consumption and prices
accelerated. The international debt crisis of 1998 dampened world economic
growth and oil prices fell. Now that most nations are in a growth phase
again, energy prices are pressing higher. We think that the upward pressure
on energy prices will continue and intensify in the years to come.Profit
Squeeze
The rise in energy costs has widespread implications for corporate
profitability. In announcing lower than expected earnings many companies
are citing weak European currencies (notably the euro) as the primary
reason. Weakness in European currencies often correlates with high oil
prices. Companies that do business in Europe are seeing the revenues
and profits they earn in euros translate into fewer U.S. dollars. Energy
prices have a more obvious impact on transportation and raw material
prices. Many companies are complaining that higher shipping costs and
more expensive raw materials are hurting profitability. Consumer patterns
are also affected by higher energy prices with more of a family’s
budget going to gasoline and heating oil and less to clothes and computers.
Tightness in the labor market and the collapse of dot.com stocks are
the other factors impacting corporate profits. For the first time in
twenty years workers have companies over a barrel. Help wanted signs
are everywhere as companies scramble to find staff from a labor pool
that is all but dried up. Some companies are enticing workers with higher
pay and flex time, while others offer generous stock options. Stock
options are a hidden expense that reduce corporate results over a longer
period of time. The collapse of internet related stocks is having a
swift, substantial impact on advertisers, technology equipment suppliers,
and e-commerce consulting firms. The dot.com companies raised billions
of dollars from stock offerings last year and frenetically spent the
money setting up web sites and advertising their existence. Now that
the seed money is all gone, the companies are disappearing, most without
a trace of recognition having been realized. It’s a tough time
to be a shareholder of a dot.com company or any of the companies that
benefited from their lavish spending over the past year.
Current Strategy
Investors are shell shocked trying to survive the worst stock market
in eighteen years. High stock market valuations, profit pressures, interest
rate hikes, and relentless selling by corporate insiders, have made
the market a discouraging place for shareholders. Investors seeking
shelter from the storm are attracted to companies that have little foreign
(euro) exposure, limited competition from imports, are fully staffed,
have modest valuations, are recession resistant, and NOT internet related.
What a difference a year makes! The problem is that few such companies
exist. Energy stocks are a possibility, but are rather high in price.
The same can be said of the other safe havens, such as drug stocks and
utilities.
We sold positions throughout 1999 and have continued to
garner profits in the current year. Capital preservation has been our
primary concern over the past eighteen months. Overpriced and vulnerable
holdings have been weeded from our clients’ portfolios. We have
kept remnant positions ( fractions of the original holding) in a few
blue chip technology companies such as Cisco, IBM, Texas Instruments,
and ADC Telecoms. Even these relatively small, scaled down positions
are hurting results as all tech stocks tumble.
Over the past nine months we have made some new buys in the food sector,
along with a few purchases of beaten down industrial and technology
stocks. One recent purchase, Brio Technology, was selling for 62 per
share in March before falling to 8 dollars per share where we bought
it in July. We continue our disciplined approach to buying with the
hope of not overpaying for any purchase.
Bonds and cash are important components of our accounts in difficult
market environments. The interest income from bonds and cash produce
a positive flow that can be used to buy stocks or meet the cash withdrawal
needs of our clients.
