By Sam Stovall After a weak performance by stocks in the industrial sector thus far in 2005, investors may be asking themselves: Is it quitting time yet? Year-to-date through June 30, the S&P Industrials index, which represented 11.2% of the Standard & Poor's 500-stock index, was down 5.7%, vs. a 1.7% decline for the S&P 500. In 2004, this sector index was up 16%, vs. a 9% rise for the S&P 500.
Standard & Poor's Equity Research Services recommends that investors underweight the S&P 500 Industrials sector in their portfolios. That recommendation springs from S&P equity analysts' neutral fundamental outlook for this sector. (There are 16 subindustry indexes in this sector, with Industrial Conglomerates being the largest, at 41% of the sector's market value.)
While S&P thinks several industrial subindustries will soon experience downturns or slower growth, it also sees opportunities in groups where businesses are starting to recover, or in those that will have extended periods of earnings growth. S&P analysts are currently positive on segments of the industrials group that perform well in the late stages of an economic expansion, such as building products, construction, and trading companies, but are neutral to negative on a majority of remaining subindustries.
BROKEN TREND. The sector trades at a price-to-earnings ratio on estimated 2005 earnings per share of 17 times, vs. 16 times for the overall market. This sector's market-weighted average S&P STARS ranking of 3.1 (out of 5) is well below the average of 3.7 for the S&P 500.
The sector looks less than appealing from another standpoint. S&P's technical outlook is negative, as the sector index has broken its more than two-year uptrend off the 2003 lows. S&P believes it's headed for a major correction. One indication: For the first time since 2002, the industrial sector has traced out lower highs and lower lows, a sign of weakening technical strength.
The sector's relative strength vs. the S&P 500 (see chart, below) has broken down on both an intermediate- and long-term basis, suggesting that the sector could roll over. In addition, there has been a negative divergence for the weekly moving average convergence/divergence, or MACD, indicator -- signaling a longer-term weakening in momentum. Initial chart
support lies in the 240 to 260 zone, and S&P sees this range being tested sometime in 2005.
In summary, since S&P sees limited opportunities from a fundamental basis as a result of the expected adverse impact from elevated oil prices and is concerned by the eroding technical outlook, it believes this sector will underperform the S&P 500 in the months ahead.
Source: Standard & Poor's
Industry Momentum List Update
For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), and their proxies (the highest STARS-ranked companies in the sub-industry index -- a tie goes to the largest market value) as of June 30, 2005.
S&P STARS Rank
Distillers & Vintners
Fertilizers & Agr. Chem.
Integrated Oil & Gas
Managed Health Care
Oil & Gas Drilling
Oil & Gas E&P
Oil & Gas Refg. & Mktg.
S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.
S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:
S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.
S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.
S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.
Standard & Poor's Equity Research Services: Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo.
In the U.S.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.8% of issuers with buy recommendations, 56.7% with hold recommendations and 12.5% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 29.2% of issuers with buy recommendations, 50.5% with hold recommendations and 20.3% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 34.3% of issuers with buy recommendations, 48.0% with hold recommendations and 17.7% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.2% with hold recommendations and 13.8% with sell recommendations.
5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.
4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.
3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.
2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.
1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.
Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.
For All Regions:
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
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Readers should note that opinions derived from technical analysis might differ from those of Standard & Poor's fundamental recommendations. Stovall is chief investment strategist for Standard & Poor's