A World of Woe for Big U.S. Exporters?

Strong growth abroad has helped U.S. companies outperform despite weakness at home. But the global economy shows signs of cooling

A rare bright spot in the U.S. stock market this year has been big exporters. Although the domestic economy was weak, industrial outfits like Caterpillar (CAT) rushed to meet the seemingly insatiable demand for their products from booming overseas economies.

But now many worry that the global economy, dragged down by high oil prices and signs of accelerating inflation, is following the U.S. into a slowdown. The prospect of slackening demand from Europe and emerging economies has spooked investors and helped drive the stocks of big exporters lower in recent weeks.

Weaker demand

The change in market sentiment has been sudden. Caterpillar plunged 12% in just six trading sessions in late June and early July. Industrial stocks are down 14% in the past month, the worst-performing sector except for financials, according to data from Capital IQ.

Boosted by rising prices for oil and other commodities, inflation is spiking around the world. The problem is worst in "overheated" emerging economies, says Jerry Webman, chief economist at OppenheimerFunds. "Some of them are going to cool off considerably," he warns.

Central bankers around the world are throwing cold water on their economies by raising interest rates. And inflation isn't just a concern in emerging economies. The European Central Bank hiked rates on July 3 to fight inflation, despite worries European economies are slowing down, and the U.S. Federal Reserve has signaled it won't be cutting rates anytime soon.

The prospects for a global slowdown have been on investors' minds for months. But the deeper worries about U.S. exporters surfaced just recently. On June 25, Rockwell Automation (ROK) warned that profits would fall short of expectations. The industrial parts maker said it was suffering from weak sales not only in the U.S. but in Europe. On June 26, OshKosh (OSK) said it expects a loss next quarter. The truckmaker blamed a weak nonresidential construction market in Europe.

Troubling Omen

Big U.S. industrial companies with global reach—like Caterpillar, United Technologies (UTX), 3M (MMM), General Electric (GE), and Honeywell (HON)—start reporting second-quarter earnings in mid-July. Rockwell and OshKosh are tiny compared with those giants, but their profit warnings amount to a troubling omen.

Costs of energy, raw materials, and shipping had already skyrocketed, and now "evidence is starting to unfold of slower international markets," says Longbow Research analyst Eli Lustgarten. If demand weakens, it becomes harder to raise prices to cover higher costs. Plus, while the weak U.S. dollar has boosted overseas profits in recent quarters, there is evidence that direct currency benefit could disappear by the end of the year as the dollar stabilizes, Lustgarten says.

Analysts and economists make clear that they're not saying economic growth will stop worldwide. "We see it as a growth slowdown as opposed to a recession," says James Moffett, portfolio manager of the UMB Scout International Fund (UMBWX).

However, central bankers seem to know that higher rates and slower growth are necessary to get control of rampant inflation.

"In order to break the price of oil, a fair amount of the world has to slow down," says Bob Baur, chief global economist for Principal Global Investors (PFG).

No relief soon

Some parts of the globe are clearly not slowing at all, particularly commodity-driven economies like Russia and those in the Middle East and Latin America. "At this point, commodities haven't ceased booming," Moffett says. "But at some point they will" if global growth slows.

The rest of the world may simply be catching up with economic problems in the U.S. "Our economy is probably leading the rest of the world," Moffett says. "We led it down, and we'll probably lead it back up."

But how long will it take for a rebound in the U.S. to materialize? Lower commodity prices would almost certainly benefit the U.S., particularly American consumers whose spending makes up more than two-thirds of the U.S. economy. But there's no guarantee that relief from rising oil prices is coming soon.

In the meantime, consumer spending has slowed, and threats of a global slowdown sap the U.S. economy and stock market's only source of strength. "The brightest spot in the U.S. economy has been the growth in the export sector," Webman says. "It's going to be harder to depend on that."

Holding Up Well

Some say the recent sell-off in exporters' stocks is overdone. They see signs of hope. For example, even after a slowdown, nations like China and India will still be growing quickly. Also, while growth appears to be slowing in parts of Europe such as Italy and Spain, other parts of Europe, including Germany, appear to be holding up well.

For years, investors have bet on shares of Caterpillar and other U.S. exporters because of the long-term potential of these companies amid a worldwide infrastructure building boom (BusinessWeek.com, 9/11/07). Both developed and emerging economies are spending big on roads, electricity, water and sewer systems, and on products needed to satisfy commodity demand, such as oil drilling and mining equipment.

There's little evidence this infrastructure boom is slowing. In fact, it may be accelerating, and few projects will be cancelled just because growth is slowing a bit. "Many emerging [nations] have set some money aside for a rainy day," says Michele Gambera, chief economist at Ibbotson Associates. "They're likely to keep building infrastructure during a world slowdown."

What has recently scared investors is a series of short-term setbacks—inflation, a stabilization of the U.S. dollar, evidence of slower growth in Europe, and worries about slowing growth in emerging economies. There's no way of knowing how bad these problems will get, or how long they'll last. However, they don't change the longer-term reality: The world is eager to invest in new infrastructure, and U.S. industrial concerns are well-positioned to meet that demand.

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