Industrials could outshine broader market in second quarter

NEW YORK (Reuters) - With the global economic picture worsening, earnings warnings piling up, and the dollar strengthening, the outlook for U.S. manufacturing companies might appear to be unremittingly grim. Not the case say some investors and securities analysts.

Shares of big U.S. manufacturers, which have lagged the broader U.S. market this year, could be set for a summer upswing if the earnings reports they issue over the next few weeks meet Wall Street's expectations. If that happens the sector will be a rare bright spot in an otherwise grim quarter.

Optimists note that pricing is running ahead of input costs, in some cases enough to offset the hit from a stronger dollar and softer European market. Also, fears of a European catastrophe have receded, and China's economy may have already bottomed. China data on Friday showed 7.6 percent growth in the second quarter, the slowest pace in three years, but economists noted broad stability in investment and industrial production.

Analysts expect industrial companies in the broad Standard & Poor's 500 index <.spx> to notch 9 percent earnings growth for the second quarter, helped by sales in the auto, aerospace and healthcare sectors, especially in the United States. Overall, the S&P 500 is expected to see a 2 percent profit decline.

And even if some major companies report disappointing results, some analysts and investors argue that share prices have fallen to levels that mean they can soak up some bad news.

That forecast is buoyed by the broad geographic exposure of big manufacturers including General Electric Co , Caterpillar Inc and Emerson Electric Co , that can often weather a downturn in one market - Europe, currently - by finding growth in Asia or the United States.

INFLECTION POINT?

Many multinational manufacturers are likely to lower their 2012 forecasts to account for weak European economies and slowing emerging markets, but drastic cuts are unlikely. Estimates have already come down for diversified conglomerates like Honeywell, United Tech and Danaher . But the overall picture, according to analysts, is one of a mid-cycle slowdown rather than the start of a more painful downturn.

"We don't believe Asia's crashing to a halt ... Europe is not growing much, but they're also not falling off a cliff. A lot of negativity has already been priced in," said Michael Cuggino, President of the Permanent Portfolio, which holds economically-sensitive stocks including FedEx Corp and Illinois Tool Works Inc .

3M said last month European and Chinese economies were stable and raw materials were trending in its favor. Since 3M makes relatively short-cycle products like office supplies, it felt the impact from those slowing economies earlier than peers. Sales are seen up in its healthcare, industrial and safety segments both year-over-year and sequentially, balancing continuing weakness in display and graphics.

3M probably won't cut its forecast and could even raise it, said analyst Nick Heymann of William Blair & Co, who adds that investor fears for the manufacturing stocks he covers may be overstated, setting up a potential "positive inflection point."

"Today, everybody's moaning about the economy in the industrial world and we're actually starting to see it get better," Heymann said.

An indication of possible positive bias among investors comes from companies whose fiscal quarters end in May, rather than June. Lighting maker Acuity Brands jumped last week after its earnings modestly beat forecasts.

TUG OF WAR

Two examples hint at the tug-of-war in investors' minds right now between pessimism and optimism. Truck engine maker Cummins Inc stunned investors on Tuesday by slashing its full-year revenue forecast. It blamed weakening U.S. demand for trucks and slower-than-expected growth in China, India and Brazil - markets that makers of heavy equipment have until recently described as healthy.

Cummins' stock was slammed. By contrast, when diversified manufacturer Dover Inc cut its profit forecast on Monday, its shares initially fell but finished flat, then rose in subsequent trading - a sign bad news may be priced in.

U.S. industrial shares, as measured by the Standard & Poor's capital goods industry index <.gspic>, are up just 1.7 percent this year, lagging the 6.7 percent rise of the S&P 500 index <.spx>. Their June-July recovery has been more muted. Parker Hannifin Inc , SPX Corp and Eaton Corp remain down 20 percent or more from their first-quarter highs.

Europe's debt crisis and China's slowing economy have spooked investors into buying defensive names, said Catherine Avery, president and CEO of CAIM LLC, who holds Eaton, ITW, United Technologies Corp , and Emerson Electric .

For example, Kimberly-Clark is near a record while Eaton is trading at a discount to its historical valuations.

"What we're going to be looking for this quarter is whether the U.S. is holding up for them," Avery said. "Can they maintain profit margins? Is there anything left on the cost side to help them make their numbers?"

Among the largest manufacturers, analysts on average expect earnings growth at Caterpillar in the second quarter up 52 percent; 11 percent higher at Emerson Electric; and a 9 percent increase at GE, the biggest U.S. conglomerate, according to Thomson Reuters I/B/E/S.

GE is expected to get a lift from pricing, aerospace demand and sales of energy infrastructure and services, especially to oil and gas customers.

Currency headwinds and tough markets will cause some companies to fall short of Wall Street forecasts, according to analysts at BernsteinResearch, who list Emerson, Rockwell Automation, Honeywell International and Ingersoll Rand as likely to miss expectations.

But if enough companies make their numbers or the cuts are mild, investors could start looking ahead to possible improvement in the next couple of quarters.

"A lot of these stocks are well into correction territory," said analyst Matt Collins of Edward Jones in St. Louis. "Most of the bad news has already hit and it's widely known."

(Additional reporting by Scott Malone in Schenectady, New York; Editing by Patricia Kranz and Bernard Orr)

Source: http://news.yahoo.com/industrials-could-outshine-broader-market-second-quarter-130549805--sector.html

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