Industrials

Airlines have been punished lately, trailing not only the S&P 500, but also their industrials peers. News that Delta would not meet already weak passenger yield expectations underscores that analysts still remain overly optimistic. Airlines have expanded capacity too aggressively while fuel prices were low, and are now being hit with pricing pressure as travel budgets are pruned. A simple airline margin proxy juxtaposing airline selling prices with fuel prices, signals that the industry's margin expansion will turn into a much steeper correction than analysts anticipate (bottom panel). As a result, profits are slated to underwhelm. Bottom Line: We are reiterating our high-conviction underweight stance in the S&P airlines index. The ticker symbols for the stocks in this index are: BLBG: S5AIRL - DAL, LUV, AAL, UAL, ALK. bca.uses_in_2016_07_07_002_c1 bca.uses_in_2016_07_07_002_c1

Transportation stocks are weak, reflecting profit warnings in both the trucking and rail industries. Air freight equities have been slightly more resilient, but the outlook for profits remains bearish. Global revenue ton miles are contracting, with weakness spread across all the major regions. High inventory-to-sales ratios in both developed and developing markets warn that demand for rapid delivery services will stay soft. The implication is that deflationary pricing power will persist, just as fuel costs have climbed anew. To make matters worse, FedEx stated that it was raising its capital spending outlook to better compete, continuing a trend of rising investment and growing capacity. Consequently, it will take a major resurgence in top-line growth to reverse deflationary tendencies and pressure on operating margins. Despite increasingly low valuations, we recommend staying underweight. The ticker symbols for the stocks in this index are: BLBG: S5AIRF - UPS, FDX, CHRW, EXPD. bca.uses_in_2016_06_23_001_c1 bca.uses_in_2016_06_23_001_c1

Airline stocks have been walloped of late, as the downside of an industry with high operating leverage is beginning to rear its head. The past few years of low oil prices and decent demand encouraged a large investment in capacity, which is now leaving the industry with an inability to fill planes at an attractive profit margin price point. Indeed, revenue per passenger mile is contracting and our proxy for global CPI airfares has plunged. We doubt that improvement is imminent, given that fuel prices are back on the upswing, and leading business cycle indicators continue to warn that retrenchment in travel budgets is a higher probability than expansion. Against this backdrop, airfare price concessions are likely to remain intact, or even intensify, to the detriment of airline revenue and profitability. We are sticking with a high-conviction underweight stance. The ticker symbols for the stocks in this index are: BLBG: S5AIRL - DAL, LUV, AAL, UAL, ALK. bca.uses_in_2016_06_15_001_c1 bca.uses_in_2016_06_15_001_c1

This week's report discusses whether bad news is good news for stocks, or a potential restraint. Tumbling long-term yields argue for augmenting consumer discretionary sector weightings, <i>via</i> the movies & entertainment group.

The S&P industrials sector has led the deep cyclical sector recovery this year, validating our upgrade to neutral to protect against a countertrend move spurred by U.S. dollar softness. However, the industrial sector share price ratio is now near the top end of a 15-year range, suggesting major resistance. An exhaustive examination of our Indicators highlights that this year's rally has been based on portfolio repositioning and reversion from oversold conditions rather than expectations of a sustainable earnings recovery. Valuations have gone from cheap to neutral, implying that further gains require earnings outperformance. The objective message from our industrials Cyclical Macro Indicator is that relative forward earnings estimates will continue to fall. The underlying bearish force is top-line malaise. Hopes for an industrial sector revival appear to be misplaced. Once credit conditions tighten and banks become less willing to extend C&I loans, the ISM manufacturing index generally weakens. Core durable goods orders are already contracting, despite the boom in auto production over the past few years. Importantly, the corporate sector is not in a position to ramp up investment, as highlighted in last Monday's Weekly Report. That is particularly true of resource companies, where the most intense leverage pressures reside. Consequently, it is premature to bet on an industrial profit recovery and we recommend returning to an underweight stance. Please see yesterday's Weekly Report for more details. bca.uses_in_2016_05_25_001_c1 bca.uses_in_2016_05_25_001_c1

Industrial machinery stocks have surged as if China is headed back to double-digit GDP growth and the U.S. dollar is going to reverse all of its recent year's gains. That combined scenario would produce a rebound in sales growth, and allow investors to bet on increased operating leverage. But that is wildly optimistic, especially given that the sales outlook remains murky. Our global machinery new order proxy is contracting. Global machinery exports have also gone ex-growth. Importantly, leading indicators of new orders are bearish. For instance, BCA's Global CapEx Indicator is heralding a contraction in developed country capital formation. That does not bode well for global output growth, and by extension, machinery consumption. Coal and other commodities also provide a good read for future industrial machinery demand. Clearly, coal is warning that machinery new orders will stay punk. Whiffs of reflation in China have supported other commodity prices, but it is premature to extrapolate this liquidity-driven bounce into a demand-driven upturn. Loan demand is still anemic, and machinery stocks have front run any improvement in China's cyclical outlook (bottom panel). Use the rally in the SP& industrial machinery index to downshift to an underweight position.The ticker symbols for the stocks in this index are: BLBG: S5INDM - ITW, SWK, IR, PH, PNR, DOV, SNA, XYL, FLS. bca.uses_in_2016_05_25_002_c1 bca.uses_in_2016_05_25_002_c1  

Fed hawkishness reinforces the need for an imminent profit recovery to justify current valuations. Our Indicators do not signal such an outcome. Stay defensive, and return to an underweight stance in the industrials sector.

The previous Insight showed that rails are working hard to reduce cost structures. However, rail profits are still tightly linked with overall freight trends. The decline in total railcar shipment growth warns that rail earnings estimates will continue to lag those of the broad market. The two major freight categories are struggling. Coal shipments have plunged, with no imminent relief in sight, as utilities, the primary coal purchasers, are suffering from a contracting electricity production. Meanwhile, intermodal shipments, the largest freight category, have slipped into negative territory. Sagging port traffic, soggy retail sales and high inventory-to-sales ratios suggest that demand for consumer goods will remain lackluster. As a result, deflation is likely to prevail a while longer and we continue to recommend only a market neutral weight, despite the appearance of good value. The ticker symbols for the stocks in this index are: BLBG: S5RAIL - UNP, NSC, CSX, KSU. bca.uses_in_2016_05_18_002_c1 bca.uses_in_2016_05_18_002_c1

The relief rally in rail stocks has stalled at key resistance levels, but good value and extreme cost cutting efforts make it tempting to buy into any short-term weakness. Would that be a sound strategy? Top-line growth is lagging far below the rate of overall GDP growth, which is a bearish sign. However, rails have aggressively slashed costs, as both employment and capital spending have plunged. Moreover, the decline in railcar order backlogs suggests that new cars are coming on line. Rail operators lease the bulk of their cars, and tight supply in recent years boosted lease rates. As new cars hit the network, then lease rates should ease. These factors warn against extrapolating bearishness, but are they enough to bolster rail profits? Please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5RAIL - UNP, NSC, CSX, KSU. bca.uses_in_2016_05_18_001_c1 bca.uses_in_2016_05_18_001_c1

Air freight stocks have been unable to gather speed during the most recent bout of overall market strength and bid under risky assets, reflecting long-term pressure on valuation multiples. Persistently high business inventories mean that companies are not under pressure to use rapid delivery services to fulfill customer requirements. Indeed, when inventories are tight and bottlenecks exist, demand for high margin freight services increase as businesses rush to catch up. This dynamic acts as a weight on valuation multiples for air freight companies, and is unlikely to soon change based on the downbeat message regarding global trade from the IFO survey (third panel). With global trade volumes barely growing and leading indicators warning of downside risks, the message is that air freight profits will have difficulty meeting lofty expectations, particularly now that oil prices are no longer falling in support of profit margins. We are underweight this index. The ticker symbols for the stocks in this index are: BLBG: S5AIRFX - UPS, FDX, CHRW, EXPD. bca.uses_in_2016_05_11_002_c1 bca.uses_in_2016_05_11_002_c1