Recession Bet Sends Cyclicals to 2009 Low, Luring BlackRock

Recession Trade Sends Cyclicals to Two-Year Low
Concern the economy is slowing created a buying opportunity in DuPont Co. and Microsoft Corp. (MSFT), which climbed at least 4.8 percent last week, according to Kevin Rendino, a money manager at New York-based BlackRock, which oversees $3.65 trillion. Photographer: Kevin P. Casey/Bloomberg

The biggest rally in a year for companies most tied to economic growth is generating gains for BlackRock Inc. and Federated Investors Inc., and the advance may continue after valuations slipped to a two-year low.

The price-earnings ratio for the Morgan Stanley Cyclical Index tracking manufacturers, commodity producers and transportation companies has been 6.7 percent below the multiple for the bank’s consumer index, a measure of drugmakers and food companies, on average since April 29. The discount is the widest since May 2009, two months after the Standard & Poor’s 500 Index completed a 57 percent drop, its worst decline in almost eight decades, data compiled by Bloomberg show.

Concern the economy is slowing created a buying opportunity in DuPont Co. and Microsoft Corp., which climbed at least 4.8 percent last week, according to Kevin Rendino, a money manager at New York-based BlackRock, which oversees $3.65 trillion. Companies in the cyclical index may boost earnings more than 23 percent in 2011 and 2012, completing the biggest three-year advance on record, according to estimates compiled by Bloomberg.

“The group has rallied because it became very obvious to some people that we swung too far in the world-is-going-to-end campaign,” Rendino said. “The idea is whether or not the economy is going to grow in the second half of the year. The answer for that question is yes.”

Earnings Growth

Earnings for the 30 companies in the cyclical gauge, which includes Wilmington, Delaware-based DuPont and FedEx Corp. in Memphis, Tennessee, will climb 30 percent this year and 23 percent in 2012, according to analyst estimates compiled by Bloomberg. Should next year’s forecast come true, profits for the companies will have advanced sevenfold since 2009, compared with a 134 percent gain in the consumer index.

Based on analyst estimates for 2012, stocks in the measure are trading for 11.6 times earnings, compared with the average since 1993 of 17.5 times reported profits. Morgan Stanley’s consumer gauge trades for 12.5 times forecast income, according to data compiled by Bloomberg. The cyclical index has doubled since May 2009, the last time the valuation spread was this wide, data compiled by Bloomberg show.

U.S. stocks rallied last week after Greek lawmakers passed a package of austerity measures needed to avoid default and earnings from Nike Inc. and Monsanto Co. exceeded analyst estimates. The S&P 500 rose 5.6 percent to 1,339.67, its second gain in nine weeks, while Morgan Stanley’s cyclical index advanced 6.6 percent. The index lost 0.1 percent to 1,337.88 at 4 p.m. in New York today.

Second Half

“We’re in that camp that in the second half the economy will recover,” said James Dunigan, chief investment officer in Philadelphia for PNC Wealth Management, which oversees $110 billion. His firm’s holdings include Eaton Corp., a maker of truck transmission systems in Cleveland, and Milwaukee-based mining equipment producer Joy Global Inc. Cyclical companies “are cheap based upon accelerating revenue and earnings,” he said.

Energy producers and industrials will only prove inexpensive should the economic expansion accelerate, said Howard Ward, a money manager at Mario Gabelli’s Gamco Investors Inc. Those companies will trail the market should Greece’s debt crisis lead to a weakening of global growth.

‘Extend and Pretend’

“We have to assume the Greek debt issue gets another round of ‘extend and pretend’ and Washington successfully manages our own budding fiscal crisis,” said Ward, who helps oversee $35 billion in Rye, New York. “Maybe that is too strong an assumption, but I pray not. If the economic data does not improve, then the cyclicals will become even cheaper.”

Investors pulled $16.6 billion from U.S. stock mutual funds in the three weeks ended June 22, the most in a year, and have withdrawn money for nine straight weeks, according to data from the Washington-based Investment Company Institute.

Shares tied to economic growth trailed defensive stocks during the financial crisis. From the S&P 500’s record high on Oct. 9, 2007, to the 12-year low reached on March 9, 2009, household product makers fell 31 percent, health-care companies lost 40 percent and utilities slid 46 percent. Those compare with declines of 83 percent for financial firms, 65 percent for industrials and 60 percent for mining and chemical companies, according to data compiled by Bloomberg.

Too Slow

Returns over the last nine weeks show investors were speculating economic growth would be too slow to boost profits among cyclical stocks. Since the index reached its high for the year on April 29, utilities and health-care companies posted the biggest gains, rising at least 2.1 percent. Energy producers, financial companies and computer makers are down more than 2.7 percent, the data show.

Economists predict the U.S. economy will gain momentum in the second half after slowing to a 1.9 percent annual rate in the first three months of this year from 3.1 percent in the fourth quarter. Gross domestic product will expand 3.2 percent in each of the last two quarters of this year, according to the median estimate of more than 65 economists surveyed by Bloomberg.

“We expect the economy to reaccelerate and therefore we want to be positively exposed,” said Gary Flam, a fund manager for Bel Air Investment Advisors LLC in Los Angeles, which oversees $6.5 billion. “Cyclicals are the way to do that. They’re bargains now.”

FedEx Earnings

Companies such as FedEx are optimistic about earnings. The operator of the world’s biggest cargo airline predicted on June 22 that full-year profit may exceed analysts’ estimates as shipping demand climbs. The stock trades for 18.9 times reported earnings, compared with the average of 20.3 since 1996, when Bloomberg records for the stock’s valuation begin.

FedEx will earn $6.64 a share for the year ending in May, data compiled by Bloomberg show. Based on that estimate, the shares trade at 14.5 times earnings.

DuPont, a chemical maker, trades at 15.2 times reported earnings, 21 percent below its average multiple since 1980, Bloomberg data show.

Bel Air’s Flam said he anticipates economically sensitive stocks to regain leadership. He favors industrial and energy shares over companies reliant on spending by individuals.

While data last month showed a weakening housing market and consumer sentiment, the slowdown is likely to be temporary, said Philip Orlando, chief equity market strategist at Federated Investors, which oversees $354.9 billion.

“The market has largely priced in the concern about a soft patch,” Orlando said from his office in New York. “As the economy shows signs of a pick-up in the second half, cyclicals should rebound.”

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