Industrial Stocks Take ETF Bounty

Photographer: Jin Lee/Bloomberg

A trader works on the floor of the New York Stock Exchange (NYSE) in New York. Machinery makers and shipping companies in the S&P 500 have rallied 241 percent from the bear market’s bottom in 2009, compared with a 308 percent gain in consumer discretionary and 257 percent by financial shares. Close

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Photographer: Jin Lee/Bloomberg

A trader works on the floor of the New York Stock Exchange (NYSE) in New York. Machinery makers and shipping companies in the S&P 500 have rallied 241 percent from the bear market’s bottom in 2009, compared with a 308 percent gain in consumer discretionary and 257 percent by financial shares.

With Twitter Inc. (TWTR) down 32 percent, high-frequency traders getting pilloried and biotechnology shares closing in on a bear market, investors can be forgiven for some nostalgia.

They’re returning to industrials, a group with the fastest profit growth in the market as Alcoa Inc. starts the first-quarter earnings season tomorrow. An exchange traded fund tracking airlines, trucking companies and machinery makers in the Standard & Poor’s 500 Index rallied 1.6 percent last week and saw the value of its assets increase by the most ever, data compiled by Bloomberg show. At the same time, the Nasdaq 100 Index posted its worst one-day drop since 2011 and fell for the third week in four.

Companies from Caterpillar Inc. to Union Pacific Corp. (UNP) are leading the advance as investors embrace signs the U.S. is breaking free of the weakest recovery since World War II. While banks and retailers have done better since the bull market began five years ago, Drew Nordlicht of HighTower Advisors LLC said industrial companies are a better bet for 2014 given prospects for increased investment in infrastructure.

“You’re seeing the beginning of investors shifting money ahead of a wave of spending,” Nordlicht, managing director and partner at HighTower Advisors in San Diego, said by phone on April 3. The firm oversees about $22 billion. “The expectation is, as the economy begins to kick into a higher gear, corporate America will utilize the amount of cash (SPX) to spend on capital expenditures. The industrial is direct beneficiary of that.”

Weekly Returns

The S&P 500 rose 0.4 percent last week, reaching an all-time high of 1,890.90 on April 2, as Federal Reserve Chair Janet Yellen signaled continued monetary support for the economy. The benchmark gauge sank 1.3 percent on the final day of the week as losses in computer and biotechnology shares overshadowed Labor Department data showing the nation added 192,000 jobs in March. The Nasdaq 100 sank 2.7 percent on April 4, capping a second straight weekly loss.

The S&P 500 fell 0.5 percent to 1,854.96 at 9:44 a.m. in New York today.

While Michael Lewis’s new book “Flash Boys” sparked a nationwide debate on whether speed traders rip off the stock market, the potential hazards haven’t stopped investors from buying.

The S&P 500 Industrials Index, tracking companies such as Hartford, Connecticut-based United Technologies Corp. and Chicago-based Boeing Co., rallied 1.4 percent last week. The gauge lost 1.4 percent this year through March 28, the second-worst performance among 10 S&P 500 groups after consumer discretionary companies.

‘Fits Perfectly’

The Industrial Select Sector SPDR Fund (XLI), the biggest ETF investing in machinery producers and transportation stocks, took in the most deposits since it was created in 1998, drawing about $603 million over the five days, data compiled by Bloomberg show. The inflows marked a reversal from the first three months of 2014, when investors pulled $1 billion out of the fund.

“A fund-flows story fits perfectly with what kind of performance we’ve had out of the industrials,” Kevin Caron, a Florham Park, New Jersey-based market strategist at Stifel Nicolaus & Co., which oversees about $160 billion, said in an April 3 phone interview. “You’re buying into the hope that the economy is going to continue to improve, and that the lows we saw over the winter were due to weather.”

Investment Shift

An investor retreat from some of the bull market’s biggest winners also helped industrial shares as money shifted to companies with stable earnings, according to Jim McDonald, chief investment strategist at Chicago-based Northern Trust Corp.

The Nasdaq Biotechnology Index has tumbled 17 percent from a record high reached in February. The Dow Jones Internet Composite Index sank 8.1 percent in March, snapping an eight-month rally. Twitter, a San Francisco-based microblogging service that went public in November, tumbled 32 percent this year after surging as much as 182 percent in the first two months of the trading.

About $480 million was drained last week from the PowerShares QQQ Trust ETF (QQQ), which tracks the Nasdaq 100. The iShares Nasdaq Biotechnology ETF saw record $372 million withdrawals on April 4.

‘Real World’

“It’s a good sign that investors are selling some of the more speculative stocks and re-investing in real-world companies,” McDonald said in a phone interview on April 3. Northern Trust manages about $885 billion of assets. “A market that’s led by very, very expensive stocks is less comforting to me than one that’s led by tried-and-true industrial.”

Machinery producers and shipping companies are trading at 18.2 times reported earnings. While that’s near the highest level since 2011, it’s a fraction of the multiple for Internet stocks, which stands at 89.2, data compiled by Bloomberg show. More than 70 percent of the 121 firms in the biotechnology index were unprofitable in the past 12 months.

Industrial shares are rallying as manufacturing expanded from the U.S. to Europe. While factory data pointed to weakness in China’s economy, the government last week outlined a package of measures including railway spending. In the U.S., reports this month have shown faster-than-forecast growth in factory orders and vehicle sales.

Improving Data

U.S. gross domestic product will increase 2.7 percent this year and reach 3 percent in 2015, according to the median estimates from economists surveyed by Bloomberg. Growth among countries in the euro currency bloc is forecast to be 1.1 percent in 2014 after two years of contraction.

“We’re seeing Europe recovering, we’re seeing the U.S. still holding up pretty strong,” Todd Lowenstein, a fund manager who helps manage $16 billion at Highmark Capital Management in Los Angeles, said in an April 3 phone interview. “Your blue-chip, industrial, higher-quality names that have lagged are poised to benefit.”

Analysts bet industrial companies will continue to deliver the fastest profit growth amid a weather-related slowdown. Profits from the firms in the S&P 500 climbed a projected 17 percent in the first quarter, more than double the forecast for phone companies, the group with the second-fastest growth rate, data compiled by Bloomberg show.

Earnings at S&P 500 companies grew 1 percent, analysts now forecast, after anticipating a 6.6 percent rise in January.

Profit Momentum

Sales growth, excluding acquisitions, began to pick up steam in the second half of last year, according to Shannon O’Callaghan, an analyst with Nomura Holdings Inc. in New York, who covers industrial companies, including United Technologies and Fairfield, Connecticut-based General Electric Co. Now, with stock valuations near a three-year high, companies will need to post strong profit growth this year to keep the momentum going, he said.

“People are being a little more tactical and picking stock-by-stock opportunities,” O’Callaghan said on April 3. “When you look at the group as a whole, it’s tough to argue for more multiple expansion.”

Caterpillar, the largest maker of construction and mining equipment, rallied 13 percent this year, beating all other stocks in the Dow Jones Industrial Average. (INDU) The Peoria, Illinois-based company in January forecast 2014 sales that topped analysts’ estimates as the recovery in the U.S. building industry spurs sales of bulldozers and excavators.

Market Outperformer

Union Pacific, the biggest U.S. railroad, has achieved profit expansion every quarter of the last four years, bolstered by volume growth from industrial products and automotive. The company, based in Omaha, Nebraska, may say on April 17 that first-quarter profit increased 16 percent to $2.36 a share, according to the average analyst estimate. The stock has jumped 12 percent in 2014.

“Industrials can be an outperformer,” Richard Sichel, chief investment officer at Philadelphia Trust Co., said in an April 3 phone interview. The firm oversees $2 billion and favors industrial stocks. “You have well-run, large companies that will participate in any increase in growth.”

Machinery makers and shipping companies in the S&P 500 have rallied 241 percent from the bear market’s bottom in 2009, compared with a 308 percent gain in consumer discretionary and 257 percent by financial shares.

Business spending is still running below pre-recession levels as chief executives cut costs and lower investment to cope with an economy that’s expanded at average rate of 2.3 percent per quarter since the end of 2009, the slowest recovery since World War II, data compiled by Bloomberg show.

Cash Ready

Private non-residential fixed investment accounted for 12 percent of total GDP at the end of 2013, U.S. Bureau of Economic Analysis data compiled by Bloomberg show. While that’s in line with the historic average, it’s lower than the peak 14 percent reached in 2008.

Corporate America now has the money and the incentive to boost capital spending, according to Wayne Lin, a money manager at Baltimore-based Legg Mason Inc., which oversees $695 billion. Aging durable goods from machinery to cars need to be replaced while CEOs have been building reserves amid five years of earnings expansion.

Cash at S&P 500 companies excluding banks and utilities reached a record $1.3 trillion in the fourth quarter, according to an S&P estimate.

“We’ve had growth, but what we haven’t seen is sustained business investment,” Lin said by phone on April 3. “It’s business investment that’s going to be the next leg to support continued growth. Traditionally when that happens, it’s always good to long industrials.”

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