More than half of Russell 3000 stocks have fallen more than 20% since June, say strategists
Industrials like Caterpillar present a buying opportunity, argue Morgan Stanley strategists.
Beneath a near 13% gain for the S&P 500 so far this year, lots of stocks have been selling off, including one group of workhorse names that Morgan Stanley is now recommending that clients buy.
"We continue to favor quality [stocks], but the amount of price damage in the average stock is beginning to create a better setup for cyclical areas where fundamentals remain intact - industrials present the best risk/reward," Mike Wilson, chief U.S. equity strategist, and his team wrote in a note published Monday.
The strategists said 54% of Russell 3000 RUA stocks have fallen more than 20% since June, while the S&P 500 SPX forward price-to-earnings multiple is back near 19 times, around March lows. That's as earnings per share growth remains in the mid-teens, and more analysts have been raising earnings estimates than lowering them.
"That combination suggests the derating is much further advanced than the index price level alone would imply," said Wilson and his colleagues. Derating happens when the share price of a company falls, even as underlying earnings are holding up, resulting in a lower price-to-earnings multiple.
They said a shift towards asset-light, services-oriented businesses, has meant parts of the asset heavy universe look more attractive after that recent de-rating.
The "asset-heavy universe" of industrials including names such as Caterpillar (CAT) and General Dynamics (GD) is particularly attractive to the strategists. The number of analysts raising earnings forecasts versus cutting them for industrial stocks has jumped to 38% currently from 16% in February, even as stock prices have deteriorated, they noted. The group's year-over-year price gain has slowed to 10% from 49%.
"On 30 years of monthly data, breadth at today's level has typically been with a year-over-year gain of about 30%, leaving the group materially below where revisions would imply," they said.
Fundamental support for those stocks is broadening out, with manufacturing backlogs ramping up across machinery, fabricated metals and other categories, and manufacturing data showing a buildup in orders, strategists said. The debate has shifted from demand to whether companies can convert new orders into profit, when taking account of costs.
As for their stock ideas, Morgan Stanley screened for industrial stock ideas in the top third of their group of quality stocks - they have defined those in the past as well-managed companies with sustainably high, long-term returns and strong balance sheets. The screener picks have also seen improvement in forward EPS since the end of June and a fall in the stock of more than 10% since then. Underweight-rated stocks were excluded.
Ticker Company Name Market Cap ($MM) Price ($) CSL Carlisle Companies Incorporated 12,915 322.17 CAT Caterpillar Inc. 379,852 810.79 GD General Dynamics Corporation 90,020 331.83 ITW Illinois Tool Works Inc. 74,287 257.28 EME EMCOR Group, Inc. 33,922 754.49 NOC Northrop Grumman Corp. 68,474 483.48 POWL Powell Industries, Inc. 6,944 184.47 ROK Rockwell Automation, Inc. 49,133 435.33 AOS A. O. Smith Corporation 6,236 56.37 SNA Snap-on Incorporated 19,021 363.35 MLI Mueller Industries, Inc. 13,563 60.61 VICR Vicor Corporation 10,612 288.94 ESE ESCO Technologies Inc. 6,993 265.11 SSD Simpson Manufacturing Co., Inc. 7,074 170.88 VRT Vertiv Holdings Co. Class A 94,753 241.31 CARR Carrier Global Corp. 45,519 54.86 DRS Leonardo DRS, Inc. 9,811 36.64 NXT Nextpower Inc. 12,059 77.93 FIX Comfort Systems USA, Inc. 59,313 1,654.09 IESC IES Holdings, Inc. 13,156 321.08 ALH Alliance Laundry Holdings, Inc. 4,220 21.30 FERG Ferguson Enterprises Inc. 42,848 222.99 AYI Acuity Inc. 8,959 309.81 ENS EnerSys 6,838 183.53 AWI Armstrong World Industries, Inc. 6,875 161.93 ZWS Zurn Elkay Water Solutions Corporation 7,829 46.47 BWXT BWX Technologies, Inc. 12,533 137.00 PAYX Paychex, Inc. 35,897 98.50 WM Waste Management, Inc. 80,702 203.92 ULS UL Solutions Inc. Class A 5,197 65.62 BR Broadridge Financial Solutions, Inc. 18,194 161.10 BAH Booz Allen Hamilton Holding Corporation Class A 8,476 69.42 ODFL Old Dominion Freight Line, Inc. 36,930 173.84 Source: Compustat, Factset, Morgan Stanley Research
-Barbara Kollmeyer