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Investment Ideas U.S. industrials’ gains put to test as earnings ramp up

Investors betting on industrial stocks this year have been rewarded, with the group among the best-performing sectors so far, but that strength will be tested in the coming weeks as companies report results.

Industrials have outperformed the broader market this year, thanks in part to optimism that the United States may soon have a trade deal with China, as well as expectations the Federal Reserve will not raise interest rates again any time soon.

As first-quarter earnings for S&P 500 companies ramp up, investors will hear from Honeywell International, Union Pacific Corp. and Kansas City Southern next week.

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The S&P 500 industrials index is up more than 19 per cent for the year so far, compared with a roughly 15-per-cent gain in the S&P 500.

While industrial stocks and the rest of the market have risen on hopes that a China trade deal is near, excecutives have warned about the conflict’s impact, with the industrials space seen as one of the most sensitive.

Costs for certain raw materials have increased as the United States imposed tariffs on imports from China and other countries.

Investors will likely hear more this earnings period about the effects of the tariffs, and weakness in China and the rest of the global economy, on U.S. companies.

“Industrials and tech have been two of the sectors that have called out the risks from trade frequently on earnings calls,” said Jill Carey Hall, equity and quant strategist at Bank of America-Merrill Lynch.

“Some of them have seen valuations or estimates come down substantially on those risks.” Because of that, industrial companies could have further to gain if there is a trade deal or any reversal to existing tariffs, she said. The bank has an overweight rating on industrials this year.

The sector has continued to outperform even with problems for one of its leaders. Boeing shares were pummelled last month after its popular 737 MAX jet was involved in a second fatal crash and the aircraft was grounded worldwide.

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Results and comments from Boeing, airlines and aerospace suppliers also are likely to generate investor attention.

Wall Street analysts have been trying to gauge the financial hit to Boeing since the March deadly plane crash in Ethiopia.

At the same time, Southwest Airlines Co has cut its financial outlook for the year after being forced to pull its new fleet of 34 Boeing 737 MAX planes out of service, and United Airlines has said it would see an adverse effect on its operations if the jets remained grounded heading into the peak summer travel season.

“There’s certainly risk at companies that sell into Boeing planes, although what we’re hearing is Boeing hasn’t so far cut back on any supplier orders. That could be in second-quarter forecasts,” said Tim Ghriskey, chief investment strategist at Inverness Counsel in New York.

Boeing’s results are due April 24. Lockheed Martin and other aerospace and defense names are due the same week.

Those bullish on the industrials sector also argue that its valuation remains attractive despite this year’s strong gains.

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The S&P 500 industrial index is trading at 15.9 times forward 12-month earnings, still among the lowest of the 11 S&P sector and below the benchmark S&P 500’s 16.8 price-to-earnings ratio, according to IBES data from Refinitiv.

First-quarter earnings for the sector are expected to have increased just 1.6 per cent from a year earlier, though that’s better than the expected 2.3-per-cent decline in overall S&P 500 earnings, based on Refinitiv’s data.

Analysts see General Electric Co. as the largest drag on the industrials sector’s first-quarter earnings, based on Refinitiv’s data. If GE’s results are removed, the sector’s earnings are expected to have increased 4.0 per cent. GE is due to report April 30.

Year-over-year quarterly revenue for industrials is forecast to have gained 2.9 per cent versus a 4.9-per-cent increase expected for the S&P 500.

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