Despite data confirming a sharply slowing global economy, several analysts and investment managers say that cyclical stocks will experience a short cyclical decline and then soar by the middle of 2020, Barron's reports. “We are in the third quarter of the current short cycle downturn,” writes Julian Mitchell, an analyst with Barclays, in a new report about historic industrial declines. “The average downturn historically lasted six quarters,” he adds, as quoted by Barron's.
However, Mitchell expects the current downturn to be last only five quarters, with industrial production rising by 2Q 2020. Barry Bannister, head of institutional equity strategy at Stifel, has a similar view. “Events last week have de-risked [S&P 500] cyclical sectors,” he wrote in a recent report, according to Barron's. “President Trump gave into a mini-deal on trade--as China wanted--the Fed gave in to mini-QE (our term, not theirs)," he elaborated.
Among the cyclical stocks that may be well-positioned to bounce, should Mitchell's prediction be correct, are Caterpillar Inc. (CAT), Fastenal Co. (FAST), Union Pacific Corp. (UNP), CSX Corp. (CSX), and United Technologies Corp. (UTX), per Barron's.
- Economic growth is likely to rebound in the second half of 2020.
- This should give a boost to cyclical stocks.
- A "mini-deal" on U.S.-China trade is a recent positive for the economy.
Significance for Investors
Mitchell believes that the current environment is similar to the industrial downturn during 2015 and 2016, when the U.S. PMI fell for about 15 months, or five quarters. Meanwhile, strong sales and earnings recently reported by Fastenal, a wholesale distributor of industrial and construction supplies, may be an indicator supporting Mitchell's thesis.
“A near perfect storm of better-than-feared [third-quarter] results and coincidentally positive trade headlines sent [the stock] soaring,” as Dave Manthey, an analyst with Baird, wrote about Fastenal, as quoted by Barron's. For 3Q 2019, the company reported year-over-year increases of 7.8% for sales, 8% for net income, and 8.8% for EPS, while also beating analysts' estimates. Investors responded by sending its shares up by 17% on the next day, for its biggest single gain since 1987, per The Wall Street Journal. Fastenal is up by 39.0% year-to-date on an adjusted closing price basis through the close on Oct. 16.
Arconic Inc. (ARNC) is a leading producer of aluminum, formerly known as Alcoa. Its shares have surged by 63.9% YTD, but recently faced some selling pressure as the result of recessionary fears. Nonetheless, JPMorgan analyst Seth Seifman recently upgraded the stock to the equivalent of a buy rating, based on strong demand from the aerospace industry, while automakers continue to replace steel with aluminum to reduce weight and thus increase fuel efficiency, per another Barron's article.
“Recession is an obvious risk,” Seifman wrote in a recent research report, as quoted in that article. “Nevertheless, aerospace exposure should provide ballast for Howmet (70% of sales) while auto aluminization and shortages resulting from common alloy tariffs should limit downside at Arconic,” he added. Hownet is a division producing high-performance alloys for aerospace applications, and is scheduled to be spun off from Arconic in 2Q 2020.
After the market closed on Oct. 16, railroad CSX reported 3Q 2019 EPS that beat the estimate by 6.9%. Revenue was down by 4.8% YOY, as rail freight volumes have suffered in the face of the U.S.-China trade war, Reuters reports. Net income was down by 4.3%, but costs dropped by 8%, partly due to lower fuel prices.
Railroad Union Pacific is scheduled to report 3Q 23019 earnings on Oct. 17, followed by industrial conglomerate United Technologies on Oct. 22. heavy equipment maker Caterpillar on Oct. 23, and Arconic on Nov. 5. Caterpillar sells heavy equipment to virtually every industry worldwide, and thus is an important bellwether, not just for cyclical and industrial stocks, but for the global economy as a whole.
The current consensus estimates for Caterpillar in 3Q 2019 are sales of $13.5 billion, down 0.1% YOY, and EPS of $2.90, up by 1.4%. Caterpillar's shares are up by 4.5% YTD, and recently advanced 9.2% from an intraday low on Oct. 8.