There’s a tug of war going on in the stock market.
On one side, there’s the hope of investors that the tax cut will mean higher capital spending and bolster sales for companies in the S&P 500 Industrials sector.
On the other side, there’s the fear of investors that the market is seeing peak profit margins, and future results have no where to go but south.
Right now, the fear is winning.
It’s easy to understand why investors are uneasy. Talk of a trade war—and the potential damage it could do to the business of some of our largest exporting corporations—is unnerving.
As are the rising prices of raw materials and a tight labor market. But peak panic really kicked into high gear after Caterpillar’s Q1 conference call when management told investors that Q1 adjusted profits per share would be the “high-water mark of the year.” Investors headed for the hills after assuming that the company’s profits had peaked for the cycle.
We had thought at the time that the company was referring to peak earnings just for this year, and management soon clarified that the comment wasn’t meant to suggest that its business is peaking, a 5/8 Bloomberg article reported. However, the damage was done to investors’ psyches, and since then the Industrials shares have continued to lag the broader market—even though the sector’s valuation is low and industrial production has continued to reach new highs, as Debbie explains below.
Here’s a look at how the Industrials sector’s performance stacks up against the other 10 sectors’ in the S&P 500 ytd through Tuesday’s close—falling smack dab in the middle of the pack: Tech (9.7%), Energy (6.7), Consumer Discretionary (5.8), S&P 500 (1.4), Financials (0.7), Health Care (-0.3), Industrials (-2.1), Materials (-2.6), Utilities (-5.8), Real Estate (-6.9), Telecom Services (-12.7), and Consumer Staples (-14.0) (Fig. 1).
The Industrials sector’s ytd performance doesn’t reflect the extent of the damage done to some of the more cyclical industries in the sector. The list of industries that have suffered the most damage ytd includes: Airlines (-12.7%), Industrial Conglomerates (-10.6), Building Products (-7.5), Construction Machinery & Heavy Trucks (-7.1), Agricultural & Farm Machinery (-7.0), Industrial Machinery (-6.9), Construction & Engineering (-5.9), Environmental & Facilities Services (-3.6), Electrical Components & Equipment (-3.2), and Air Freight & Logistics (-1.3).
To be fair, the woes of General Electric have had an outsized impact on the sector. Without the downward pull of GE, the Industrial Conglomerates industry would be down around 8.4% ytd, and the Industrials sector would be down 1.4%. Likewise, the recent jump in oil prices has had an outsized impact on the Airline industry. Without GE and Airlines, Industrials would be up about 0.6% ytd.
The industries in the Industrials sector that have been outperforming ytd lean toward services industries: Diversified Support Services (17.5%), Human Resources & Employment Services (13.0), Trucking (7.2), Railroads (6.6), Aerospace & Defense (5.5), Trading Companies & Distributors (5.1), and Research & Consulting Services (2.5).
The sharp downdraft in the S&P 500 Industrials share price index and the upward direction of analysts’ recent earnings estimate revisions have left the sector much more reasonably valued than just a month ago. The S&P 500 Industrials’ revenues are expected to increase 7.1% this year and 4.7% in 2019 (Fig. 2). Analysts forecast an even faster jump in earnings: 19.3% in 2018 and 12.4% in 2019 (Fig. 3). As a result, the sector’s forward P/E has dropped to 16.3, from the recent peak of 19.5 hit in mid-January. And its P/E-to-growth ratio has fallen sharply to 1.0 from 1.6 in late 2016 (Fig. 4).
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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