Go to the Globe and Mail homepage

Jump to main navigationJump to main content



U.S. industrial shares show profit pessimism Add to ...

U.S. industrial stocks are flashing yellow, having lost a fifth of their value in the last two months in what some describe as a warning that another recession is looming.

The market is suggesting U.S. manufacturing multinationals may be poised to cut earnings estimates or ratchet down expectations for next year, as slowing economies and uncertainty over any resolution of Europe’s debt problems raise more questions about demand for high-value capital goods.

The Standard & Poor’s Capital Goods index has fallen more than 20 per cent since mid-July, when General Electric Co. , Caterpillar Inc. , 3M Co. and other big manufacturers began reporting second-quarter results. That is a steeper decline than the broad S&P 500 index’s 13 per cent slide.

Even as the shares have sunk, management of top U.S. manufacturers and the Wall Street analysts that follow them have largely stood by profit targets that call for double-digit-percentage growth in the second half of the year.

Industrial distributor W.W. Grainger said on Monday that August sales rose at the same pace as in July. Danaher Corp’s chief executive officer said last week that he felt “very good” about the conglomerate’s third-quarter forecast.

This month will determine who is right – bullish managers or skittish investors – since September accounts for up to 45 per cent of third-quarter sales. The companies will begin reporting their results in October.


Nomura analyst Shannon O’Callaghan cut 2012 earnings estimates for a dozen manufacturing giants, including GE, Danaher, 3M and Tyco International , to an average of 9 per cent below consensus.

For some companies, such as Ingersoll Rand and SPX Corp , his estimates are 17 per cent below the Wall Street average. Mr. O’Callaghan also lowered the companies’ share-price targets.

His reasoning? Profit warnings are coming.

“Further slowing has yet to manifest itself via guidance cuts ... but will likely do so in coming months,” Mr. O’Callaghan said in a note to clients, adding price-to-earnings ratios have come down in anticipation of such cuts.

Mr. O’Callaghan said the stocks could do well if recession risks erode, but “that is still a big ‘if’ right now.”

Headwinds to 2012 forecasts include the European debt crisis; political gridlock in Washington; and the possibility that China’s efforts to curb inflation could slow its economy too much.

Stocks are pricing in not just a slowdown but an actual decline in earnings. Cooper Industries , Honeywell International Inc. , Dover Corp. and Eaton Corp. are trading at 10 or less times next year’s estimated earnings, only slightly above their multiples in the last recession.

Only financial stocks have fallen more steeply so far this year. Industrials were the second-best-performing sector in 2010 as the global recovery gained speed, but that recovery is increasingly in doubt, according to Standard & Poor’s.


Bulls point to healthy demand from markets like utilities and commercial aerospace. Home prices are stabilizing, and credit remains accessible to large companies. Some late-cycle markets, such as nonresidential construction, have yet to recover, but are unlikely to fall much further.

Some economists expect U.S. economic growth to accelerate next year. An index of U.S. factory activity in August came in above estimates and remains at a level that indicates expansion.

Still, electrical and multi-industry stocks trade at a discount to the S&P 500 index based on expected 2012 profits for the first time since the 2008-2009 recession: evidence that investors have lost confidence in Wall Street estimates.

“It’s goblins in people’s heads right now,” said analyst Nick Heymann of William Blair & Co. “The fear factor is casting a far, far bigger shadow on valuations than the fundamentals.”

Most companies are likely to meet forecasts when they report third-quarter results, said Vertical Research Partners analyst Jeff Sprague. But they may start to talk down expectations about the fourth quarter and beyond while giving 2012 forecasts that are below Wall Street expectations.

“It feels like we’ve discounted a full-fledged recession, and the odds are that we might have some kind muddle-through, slow growth,” Mr. Sprague said. “There could be a pretty significant bounce-back if it turns out September was OK.”

Report Typo/Error

Follow us on Twitter: @GlobeInvestor


Next story




Most popular videos »

More from The Globe and Mail

Most popular