By Sam Stovall Late October saw the S&P Construction & Farm Machinery subindustry index' rolling 12-month relative-strength ranking weaken after the index weathered a nearly 6% decline. What happened? One of its bellwether constituents, Caterpillar (CAT), reported a worse-than-expected third-quarter earnings report.
During 2004, this subindex, which also includes makers of heavy-duty trucks and consists of 17 large-, mid-, and small-cap companies, outperformed the broader market, rising 21%, while the S&P 1500 advanced 10%. It's a different story in 2005, however: Year-to-date through Oct. 21, this subindex declined 9.7%, while the overall market fell 2.1%.
BEHIND THE PACK. The rolling 12-month relative-strength price chart (pictured below) demonstrates this recent underperformance. As a reminder, the jagged blue line represents the subindustry index' rolling 52-week price performance as 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 subindex' 14-year mean relative strength.
After its market outperformance from 2000 through 2004, it appears as if this group is finding itself relegated to the role of a laggard. To make sure, I checked with Anthony Fiore, S&P's diversified machinery analyst, who covers these stocks.
Fiore says S&P's fundamental outlook for the subindustry is neutral. However, because different factors affect each segment's operating and financial performance, S&P believes they should be looked at separately.
Construction Equipment: Although residential real estate activity has remained relatively strong, S&P believes the main factor behind recovery in the construction-equipment-manufacturing market should be improvement of nonresidential construction.
Fiore points out that spending in this category during August was estimated at a seasonally adjusted annual rate of $243.8 billion. This topped the year-earlier level by 3.7% and was fractionally higher on a sequential basis, he adds.
Despite the still-choppy trends, S&P believes the recent renewal of Federal highway legislation, combined with an expected increase in demand for office space due to rising employment levels, should result in an improved nonresidential construction market in 2005.
Farm Equipment: According to the U.S. Agriculture Dept., farm income -- the primary driver of tractor, harvester, and combine sales -- will likely remain at a high level in 2005. Although net farm income is projected to decline about 13% in 2005 from 2004, the current forecast of $71.8 billion represents a level about 37% above the 10-year average of $52.4 billion.
S&P attributes this showing to strong crop yields, increased international demand, and higher government payments. Given the leading nature of farm income, and that yearly unit sales of tractors and combines have declined 4.6% on average since 1997, Fiore anticipates that favorable conditions will continue over the next 12 months for farm equipment manufacturers.
Heavy-Duty Trucks: Manufacturers in this segment appear to reside in the middle stages of a cyclical upturn, says Fiore, as improved carrier profitability, combined with an aging motor fleet, is driving strong replacement demand for heavy-duty trucks.
As in prior industry cycles, however, S&P expects the shares of truck manufacturers to trade at lower multiples during peak or near-peak earnings-per-share years. Based on the growing maturity of the truck-replacement cycle, Fiore sees limited upside potential for many of the stocks in this group.
So there you have it. In S&P's view, the subindustry's weakening momentum picture, combined with the group's neutral investment outlook, lead us to believe this industry won't outperform the market again in the coming year.
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 Oct. 21, 2005.
Construction & Engineering
Diversified Metals & Mining
Fertilizers & Agricultural Chemicals
Health Care Services
Managed Health Care
Oil & Gas Drilling
Oil & Gas Exploration & Production
Oil & Gas Refining & Marketing
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In the U.S.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 28.7% of issuers with buy recommendations, 60.3% with hold recommendations and 11.0% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.8% of issuers with buy recommendations, 44.8% with hold recommendations and 20.4% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 28.1% of issuers with buy recommendations, 51.1% with hold recommendations and 20.8% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 29.3% of issuers with buy recommendations, 57.7% with hold recommendations and 13.0% with sell recommendations.
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Stovall is chief investment strategist for Standard & Poor's