Mon, Jun 2, 2014 - 10:49am

I generally do not get too surprised, but this year has been the exception. I have been surprised by the stunning drop in the yield on the 10-year Treasury note, which has fallen from roughly 3% at year’s end to a yield yelp low of 2.4% last week. I have been surprised, given my call to avoid utility stocks, that the D-J Utility Average has been the best performing major index year-to-date at +11.09%. Last week I got surprised again. I have been telling people that I thought the 1Q14 advance GDP report of +0.1% would get revised upward. Surprisingly, that GDP figure was indeed revised, but revised lower to a headlining -1.0%. The equity markets, however, did not seem too surprised as they shook off said report and rallied. Our own Chief Economist Scott Brown, Ph.D. had the following insight regarding the revised GDP number. Commentary like this from Dr. Brown and other economists likely explains why the markets were not too surprised:

The GDP revision may cause some confusion. While the headline figure was weaker than expected, most of that was due to slower inventory growth — which bodes well for future growth. Thus, while the 1Q14 growth estimate was revised down, the forecast for 2Q14 ought to be revised higher. Leaner inventories pave the way for better growth in production (all else equal). Otherwise, the story didn’t change much. Consumer spending was revised slightly higher; but remember, a good chunk of that was higher energy consumption related to the colder-than-normal winter (which will reverse in 2Q14). Personal income growth was respectable, but profits weakened (not surprising, given the bad weather). We may see a knee-jerk reaction in the markets to the headline GDP figure (-1.0%), but the details are more positive (leaner inventories). Note that personal income and spending figures for April (released tomorrow) will help to gauge the strength of the consumer into early 2014.

While attention was focused on the GDP number, I was again surprised nobody picked up on a positive story in The Wall Street Journal that incorporates many of the themes Rich Bernstein and I discussed at Raymond James’ recent national conference. The story’s title is, “Are We Underestimating America’s Fracking Boom?” The byline reads, “Check Out Sasol’s Energy Complex in Lake Charles, La.” Having followed Sasol (SSL/$59.29) in a past life I was intrigued. Sasol was formerly a South African state company that had developed the ability to “crack” natural gas into diesel fuel and other liquids. Now the company is going to build a plant in Louisiana to do the same thing. At $21 billion this would be the largest foreign investment project in U.S. history. The 3,000-acre complex will tap into America’s cheap natural gas and convert it into high-quality diesel fuel, ethylene (used in plastics, paints, packaging, etc.), and other liquids. The article goes on to note:

This is engineering on a scale so large that it requires closing 26 public roads, buying out 883 public-property lots, and hiring 7,000 workers at peak construction. Some 100 additional trucks will be on the road each day once the complex is completed. Entrepreneurs have already begun construction of a "man camp" to house 4,000 temporary workers streaming into Lake Charles for this and other projects. In that way, Sasol is a metaphor for what we don't yet understand about America's gas boom. Most know what fracking has meant for oil and gas prices. But because much of the work hasn't started yet, few appreciate the true extent of the industrialization that's about to begin. So let's put it this way, we are building a Qatar on the Bayou. From whole cloth, companies are laying new cities of fertilizer plants, boron manufacturers, methanol terminals, polymer plants, ammonia factories and paper-finishing facilities. In computer renderings, the Sasol site looks like a fearsome, steel-fitted Angkor Wat.

According to the Greater Baton Rouge Alliance, when completed some 66 industrial projects will be breaking ground over the next five years, worth about $90 billion. Currently, Louisiana’s entire GDP is $250 billion, so we are talking about a 36% increase in the state’s GDP — can you spell BOOM?!

The implications of projects like this are “transformational,” a word often used by Joel Kurtzman in his book, “Unleashing the Second American Century.” This is exactly what I have been talking about for the past few years: Energy Independence, the American Industrial Renaissance, better jobs, etc. Joel believes the four forces for America’s economic dominance are: soaring levels of creativity; massive new energy reserves; gigantic amounts of capital; and unrivaled manufacturing depth. As Joel states, “It’s like taking America’s industrial strength and layering in Saudi Arabia’s energy on top.” While most of the media is ignoring this, the stock market seems to be getting it.

[Recommended: Seven Megatrends that Will Reshape the Next Decade]

Last week the markets “got it,” leaving the many of the indices at new all-time highs. While a 38% retracement could carry the S&P 500 (SPX/1923.57) down to 1903, I do not think this is in the cards. Verily, the most surprising move by the SPX from here would be a rally into the aforementioned 1950 – 1975 level before a pullback is due. As the astute Lowry’s organization writes:

While there is still little evidence a major market top is imminent, investors should recognize that the bull market is showing signs of age, calling for more selective buying and for adjusting portfolios to account for changing market conditions. For example, while mid and small cap stocks were among the strongest performers during much of this bull market, the recent plunge in the mid and, especially, small cap indexes, suggest investor enthusiasm for these stocks has largely disappeared. Thus, while wholesale dumping of small cap stocks appears unjustified, portfolios should be regularly reviewed to identify underperforming stocks. Funds should then be repositioned into the strongest stocks, primarily among the big caps — currently the strongest market segment.

While I tend to agree with the good folks at the Lowry’s organization about the large cap complex, I would like to highlight two intriguing ideas from Raymond James’ research coverage that are not large caps. The covering fundamental analysts have laid out the bullish case for Satellite & Space company Iridium Communications (IRDM/$7.92/Strong Buy/covered by Chris Quilty) and E&P company Goodrich Petroleum (GDP/$29.00/Outperform/covered by John Freeman), both of which have convertible preferreds with decent yields. For further details, please see our analysts’ recent company comments.

[Must Read: Why the Market Ignored Bad GDP Numbers]

The call for this week: The most surprising thing that could happen here is for the SPX to continue to rally into the 1950 – 1975 level that was targeted when the SPX recorded its bullish outside-day reversal to the upside back on April 15, 2014. Indeed, in secular bull markets all the surprises tend to come on the upside…

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