The summer of 2011 has not been one of the nicer summers in recent memories. Crushing heat across much of the country is bad enough in its own right, but it is paired up with ongoing financial trouble in Europe, an unprecedented sovereign downgrade for the United States, economic worries all around and a weak stock market. Yet, even against this dour backdrop, there are still areas of the strength in corporate America.
For purposes of this article, strength refers to the momentum in corporate sales and earnings, as well as the trajectory of analyst expectations. Curiously, there are numerous divergences between those industries showing fundamental strength and stock market strength, and these may well prove to be trading opportunities for investors.
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The auto parts industry best highlights that dichotomy between financial and stock market strength. With strong results from companies ranging from American Axle (NYSE:AXL) to Dana (NYSE:DAN) to Tenneco (NYSE:TEN), the auto parts industry has shown very healthy revenue and profit momentum as car sales have risen more than 10% year-to-date. Curiously, this is also one of the weakest sectors year-to-date, as stocks in this group have fallen almost 20%. Perhaps investors have been spooked by the recent slowdown in passenger vehicle sales and have decided to take profits in names that, in many cases, have appreciated several times over since the worst of the recession. (For related reading, see 2011 Cars With The Highest Resale Value.)
Chemical companies have had to deal with higher petroleum, hydrocarbon and energy costs, but the sector as a whole pushed through higher prices and reaped excellent demand growth from emerging markets. Even still, demand for basic chemicals is closely tied to overall global economic growth and the sagging outlook for growth may be responsible for the underwhelming recent performance of these stocks. While major chemical companies like DuPont (NYSE:DD) and BASF have worked hard to diversify their businesses and become less cyclical, the fact remains that as the economy goes, so too goes the chemical sector. (Now known as one of the world's largest chemical companies, DuPont got its start in gunpowder. For more, see 5 Of The Most Adaptive Companies.)
Railroads have been on a tear for a while now, benefiting from the higher traffic coming from the economic recovery. More traffic has allowed these companies to wring more operating profits out of their networks. Moreover, persistently high fuel costs have led customers to rely more on intermodal shipping. As intermodal carries higher margins, this has been a win-win for the industry - capturing more tonnage from the trucking industry and delivering better profits for shareholders.
Rails have been the strongest stocks of these out-performing industries (about 3% year to date) as investors weigh out the pluses and minuses of slowing rail traffic growth and intermodal expansion. Rail traffic is still well off its peaks, though, so investors looking for a long-term play on improving U.S. economic fundamentals can still find opportunity in the rail sector.
Oil prices are volatile as investors try to digest the ongoing troubles in Europe and the weakening economy in the U.S. and interpret their impact on global growth and global energy demand. Nevertheless, energy companies large and small continue to see very profitable price realizations and are pushing ahead with aggressive production expansion plans.
As investors try to forecast the near-term trends in energy prices, as well as the possibility of regulatory changes to drilling practices, stock performance has been all over the map. The sector as a whole has been fairly weak (down almost 10%), but stocks like Petrohawk (NYSE:HK), Cabot (NYSE:COG) and Chesapeake Energy (NYSE:CHK) have done quite well on news (or expectation) of buyouts and responsible production growth strategies.
As oil and gas companies have looked to hold leases with production and expand their revenue base, energy service companies have seen a jump in demand for their services. This has fueled a jump not only in revenue and profits, but in the companies' order books as well. While companies like National Oilwell (NYSE:NOV) and Cameron (NYSE:CAM) look for major orders from large offshore energy projects, more traditional service providers like Schlumberger (NYSE:SLB) and Haliburton (NYSE:HAL) are looking to couple a recovery in international markets with very strong North American demand.
Looking at the Flip Side
In contrast to the five industries above, where strong underlying revenue and profit performance has not necessarily translated into hot stocks, the packaged food and agricultural input industries have done much better from a stock market perspective. The packaged food sector has risen more than 6% this year, while ag input stocks are up better than 3%.
To a large extent, this looks like a reaction to the troubled and uncertain economic times. Packaged food companies are one of those groups that investors believe can weather any sustained economic downturn, as people always need to eat and cannot really postpone grocery shopping. Ag inputs, on the other hand, play into several trends that appeal to investors - commodity prices have been strong and agriculture input companies like Potash (NYSE:POT) and Syngenta (NYSE:SYT) give investors a way to play increasing food prices and agriculture land values.
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The Bottom Line
Looking at the dichotomy between fundamentals and stock market performance, it is easy to remember the adage that Wall Street is a forward-looking discounting mechanism. In other words, while the performance of stocks in sectors like auto parts and chemicals have been strong, the action in the stocks indicates that investors expect that performance to start tapering off. On the flip side, investors seem to think that packaged food stocks offer some safety and security in an uncertain world and that agricultural will remain an attractive sector for some time to come.
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