A New Index Trades Up
A recent addition to the is the S&P 1500 Trading Companies & Distributors subindustry index. This index consists of eight large-, mid-, and small-cap companies that distribute industrial and commercial products, three of which are followed analytically by S&P. Year to date through May 26, 2006, this subindustry index has advanced 12%, vs. a 2.9% rise in the S&P Composite 1500 Index. During 2005, this group gained 15.8%, vs. a 3.8% advance for the "1500."
As can be seen in the chart , the rolling 12-month relative price performance for this group has exceeded that for the overall market. As a reminder, the jagged blue line represents the subindustry index's rolling 52-week price performance compared with the 52-week performance for the S&P 1500.
Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the subindustry index's 15-year mean relative strength.
So now the question is, "is there any upside potential left?" Stewart Scharf, S&P's analyst covering this group, says that even though the group's projected 2006 p-e-to-five-year EPS growth ratio is slightly above the S&P 1500's, he is maintaining his positive investment outlook for this subindustry. Scharf expects capital spending to increase, driven by S&P's forecast of 10.3% growth in producers' durable equipment investment and a 3.3% rise in consumer spending.
Scharf expects favorable economic prospects to continue to boost demand for industrial and commercial products and non-residential construction. Although oil prices remain volatile, in part due to geopolitical unrest in Nigeria and the Middle East, S&P thinks prices will retreat somewhat and stabilize during the balance of 2006, albeit at a high level.
S&P expects the Federal Reserve to leave interest rates at their current 5% level (raised another 25 basis points in May) at least for several months, based on monthly economic data. In S&P's view, the strong data in the first quarter suggest that higher interest rates pose little danger to growth, while inflation (before food and energy), which has picked up slightly, basically remains calm. S&P projects that core inflation will rise only 2.9% in 2006 and 1.8% in 2007.
Although volatile energy costs may reduce productivity growth somewhat if prices continue to rise significantly and imports from Asia continue to outpace exports, S&P thinks the revaluation of the Chinese yuan, and a possible tariff on imports from China, could aid domestic production. S&P sees more than half of growth derived from technological change, and still expects this group to benefit from increased demand for industrial and maintenance products.
S&P expects a 4% rise in durable goods orders for 2006, slipping to 2.8% growth for 2007; non-durable goods orders are projected to increase 3.6% in 2006 and 2.3% in 2007. Real gross-domestic-product growth for 2006 is projected at 3.4%, with S&P projecting growth of 2.6% for 2007. Capacity utilization rose sequentially to 81.9% in April from 81.3% -- a level exceeding 80% normally triggers expansion. Industrial production was up a strong 0.8% in April, above market projections. S&P still sees fluctuating foreign currencies and volatile commodities prices, and Scharf expects the companies in this group to continue to control inventory levels.
So there you have it. From both a fundamental and momentum standpoint, S&P believes the investment outlook for the S&P Trading Companies & Distributors group is favorable over the coming 12 months. Scharf's top pick in the group is W.W. Grainger (GWW), which he ranks 5 STARS (strong buy).
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) as of May 26, 2006.