Food for Thought

Dear Client,
  This bull market may be a senior citizen… just a few months away from its sixth birthday, it’s already the fourth longest of the past four decades. But the old charger still has plenty of vigor, supported by a vibrant U.S. economy, lower oil prices, a healthier consumer and a strengthening greenback. In fact, with corporate earnings likely to grow 8% – 10% on average for the Standard & Poor’s 500 companies…

INVESTING:  U.S. stocks should offer an 11% total return over the coming year… a 9% gain for the S&P plus a two percentage point average dividend yield. Moreover, although share prices are carrying a bit of premium at 16 times estimated 2015 earnings, the market as a whole is well shy of past market tops. Still, it’ll take greater care to profit in 2015: More volatility and fewer firms lifted by a rising tide mean picking the right stocks is likely to be critical.

  Among the currents to be negotiated: Higher interest rates. The Federal Reserve is poised to nudge up rates, midyear of later in 2015. The moves will likely be modest and gradual. With overseas demand for the safety of U.S. assets remaining high and expectations of inflation, low… the impact of both short- and long-term rate hikes should be benign. But if the Fed acts more aggressively or sooner than expected or if bond yields run up, consider a shift to defensive stocks… companies that make the stuff we use every day. Think makers of toothpaste, cereal, diapers, toilet paper, laundry detergent and so on.

  Then there’s the oil price drop, which tarnishes the luster of energy firms. Note, though, that a few, including behemoths Schlumberger and Halliburton, have already been so beaten up that they’re looking like bargains to hold long term. The decline is a boon for companies that rely on oil-based raw materials. Chemical firms, such as PPG Industries, which makes automotive finishes, house paint and industrial coatings, are a good bet. Also Goodyear Tire & Rubber or the like. Lower gas pump prices mean consumers have more to spend elsewhere… good news for retailers. Consider Wal-Mart, Macy’s and discounter TJX Companies. But steer clear of Sears and J.C.Penney, which will both continue to struggle.

  And a muscled-up dollar. Big exporters and multinationals will feel the pain of products that cost foreign consumers more and overseas earnings that translate into fewer dollars. Conversely, firms that derive the bulk of their sales in the U.S. are likely to perform more favorably. Some candidates to consider: UnitedHealth Group, drugstore chain CVS, insurer Allstate and steelmaker Nucor. And these small caps: Krispy Kreme Soughnuts, Mueller Water Products and Regal Entertainment.

THE ECONOMY:  Strong third-quarter GDP growth reinforces our expectations for 2015. Momentum critical for a self-sustaining growth cycle is finally picking up, and a gain in the 3% neighborhood…the best since 2005…over the course of 2015 is likely. That compares with an expected annual gain of just 2.2% for this year. Consumer confidence should head higher in coming months…another bit of good economic news helping to buoy spending this holiday season and beyond. Lower prices at the gas pump and more-stable food prices will be big factors. Because consumers buy gasoline and food frequently, they tend to put a lot of weight on the direction of prices for those products, as well as on incomes and employment.

  Look for wage and price hikes to tick up in the weeks ahead. More midsize and small businesses say they expect to raise wages…many of them by 3% or greater. More companies also intend to kick average prices higher to preserve profit levels and meet rising supplier costs. Both moves reflect business owners’ brighter outlooks on future growth. They’re betting consumers will be willing and able to pay more. But no danger of inflation spiraling much higher. There’s still enough slack in the economy to hold the Consumer Price Index to about a 2% increase next year. Count on businesses to invest more in their own growth next year, too…bumping up capital spending by an average of about 7%, following an increase of 5% or less this year. With the economy poised for healthier, more sustained gains in 2015, corporations will put more of their gigantic cash hoards into new plant and equipment.

  Job growth in the West and South will pull further ahead of other regions next year. Bolstered by energy exploration and development in Texas, La. and Okla. in the South and by a thriving high-tech sector in the West, gains in the two regions have been running at a pace that is double that of the Midwest and Northeast. The Northeast is particularly vulnerable, with hiring muted across most of the region. The notable exceptions: NYC and Boston, where financial services continue to add workers. The region’s export-oriented industries…pharmaceuticals, aerospace and technology… will be hard hit if Europe’s economic woes deepen. Soft spots in the Midwest, too. Manufacturing is picking up only modestly in Chicago and even more slowly in St. Louis, Milwaukee and other key areas. Brisk new-car sales continue to make the auto industry a bright patch, however, and strong demand for new non-defense aircraft and aerospace products is a help.

ENERGY:  Another big drop in U.S. dependence on petroleum imports coming next year as domestic crude output keeps rising and exports of refined fuels mount. Net imports of oil and petroleum products are now down to 4.8 million barrels a day…the lowest in 22 years, despite the fact that the U.S. consumes much more oil today. Next year, the level figures to slip below 4 million barrels…about 20% of consumption. Expect domestic oil production to hit 9.5 million barrels a day in 2015, up from slightly under 9 million today and the highest production rate since 1971. Plus more exports of U.S. fuel to meet brisk foreign demand for gasoline, diesel and propane. Even U.S. crude will rise as a decades-old ban on most shipments of it overseas is loosened. Overseas sales are now nearly half a million barrels a day.

  Surging natural gas production in Pa. is leading to a local glut. Spot princes for gas coming from the Marcellus Shale have dropped below the benchmark U.S. level because output is rising faster than new pipes can be built. So some nearby users…factories in W.Va., power plants and homeowners in N.J…are enjoying cheap prices. Most users are paying more now than a year ago because of high demand last winter. Moving all that gas to outside markets will take three years. New pipelines are being built as quickly as possible to transport Pa.’s gas bounty. Most projects figure to be on line by 2018, speeding up deliveries to the gas hungry Northeast.

IN THE STATES:   Look for states to fiddle with funding formulas for road and bridge projects that involve private partners. The conventional way…giving private firms a share of money raised through tolls or user fees…isn’t yielding enough return, forcing a few private operations to go belly-up or try to get out of agreements. Some states will sweeten the pot with pay for firms that hit benchmarks such as prompt removal of snow, meeting construction deadlines and the like. States will still need to rely on such public-private projects. Federal funds for state projects continue to dry up, and gas tax revenues continue to decline as motorists opt for vehicles that get more miles per gallon than earlier models.

HEALTH CARE:  Don’t be surprised if the feds up the ante for employers that self-insure: A requirement to offer coverage of more “essential services”… hospitalizations, emergency room treatment, prescription drugs, etc. Most companies that self-insure voluntarily meet the federal essential services standards required of other big firms. But some…largely in retail, food service and other low-wage industries…do not, prompting critics to charge that self-insuring provides them with a giant loophole. The earliest such a change could kick in is July 1, and that’s not especially likely. Any administrative move to add the reg is sure to be challenged in court.

  Expect more employers to tighten up on prescription drug coverage. Increasingly, they’ll require insureds to try the least costly options first…generics over brand names and cheaper, older therapies over newer ones, for example. Payment for more expensive drugs may be approved only after other options fail. Another cost of relief tactic: Limiting quantities of drugs for episodic maladies…15 pills a month instead of 30 for treatment of migraines, insomnia and so on.

  Note the increased scrutiny of employer wellness programs by the EEOC, Equal Employment Opportunity Commission. Rewarding workers who exercise or otherwise adopt healthier lifestyles can cut health care costs over the long run. At issue: When is participation no longer truly voluntary, as the law requires. The commission is suing two firms that it says are effectively compelling participation. The EEOC will issue guidelines, but not till 2015. Meanwhile, err on the side of caution.

TECH:  Wireless firms face a big shortage of skilled workers to upgrade networks. Annual spending on U.S. wireless infrastructure will top $40 billion by 2016, adding demand for antenna technicians, engineers, tower climbers and other workers. Wireless firms say community colleges and tech schools don’t keep up with advances. A new job training program will help. The Dept. of Labor is partnering with wireless companies to train workers and standardize practices in the industry. Standards will be upgraded as the technology changes, with an emphasis on safety.

  Use of spoken commands and photos to search the web will grow rapidly. Baidu, the Chinese equivalent of Google, sees half of all searches by voice or image in just five years. Google, Apple and others predict quick transitions from text as well. Such searches will boost business productivity, letting workers find parts with photos or get necessary instructions without losing use of their hands. But they’ll pose challenges for marketers that depend on word searches to trigger their advertisements or to put their sites at the top of search results. Also coming: Advanced computer chips that will enhance digital photography. New chips and software will enable phone cameras to know whether a user is indoors or out and to determine when to shoot. At a soccer game? The picture will be taken when the ball leaves the shooter’s foot or when the goaltender dives to stop a shot.

BUSINESS COSTS:  Higher paper prices on the horizon…a 6% jump for publishing-quality paper as another mill is shuttered. It’s the latest in a series of consolidations and cutbacks as publishing increasingly shifts from print on paper to electronic ink. Tough new efficiency regs for rooftop air conditioners will raise prices charged by makers. By 2019, manufacturers will have to reduce by 30% the amount of power used by units typically installed on the roofs of big-box stores, office buildings, etc. Also: A hike of up to 6.5% in 2015 hotel rates under corporate contracts. Businesses are losing bargaining power as occupancy rates rise. This year…near 64%, the highest in 15 years. Contacts won’t include extras that clients are now used to, including business center services and free breakfasts, even access to fitness centers. Expect hotels to also drive a hard bargain when it comes to renting meeting space.

CLEAN WATER:  Uncle Sam is readying a big push to clean up the Great Lakes. The new plan will unfold over the next five years, at a taxpayer cost of over $1 billion. The goal is to build on efforts that have already markedly improved water quality. Among top priorities for federal agencies: Keeping fertilizers out of the lakes. Runoff from farms and urban areas sweeps nitrogen and phosphates into the water, causing fish die-offs and sometimes rendering water unsafe for residents to drink. Restoring coastal wetlands to better filter and block harmful pollutants. And replenishing native fish species by eradicating harmful invasive threats and removing dams to let migrating fish travel easily between streams and the lakes.

CONGRESS:  The GOP-led Congress will face two big obstacles in trying to end gridlock: Some of the party’s presidential hopefuls and the man they hope to replace. The challengers will try to push House and Senate leaders further to the right. But President Obama won’t hesitate to kill any measure that pushes back too much. Veto threats will force the Republican majority to scale back its wish list: Redefining full-timers and making minor changes instead of repealing Obamacare. Trading alternative energy incentives for approval of the Keystone XL oil pipeline instead of trying to reverse Environmental Protection Agency rules for coal plants. Delaying implementation of the Volcker rule, which curbs risky investments by banks, instead of striking down the entire package of financial services reforms. Don’t expect lower business or personal tax rates. Or entitlement changes. In many ways, the next Congress will look much like the one being replaced.
Yours very truly,
THE KIPLINGER WASHINGTON EDITORS

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