Low expectations can sometimes be very beneficial for near-term stock performance as has been the case for US industrial stocks so far this year. After a dismal December, the sector easily vaulted over a low bar for fourth quarter earnings season, which has led the industrials index to be the top performing S&P sector for the month of January. The index was up over 11% for the month (January) and has now recouped nearly all the steep losses of December. The sector has also gotten a boost from further Chinese stimulus and recent dovish commentary from the Federal Reserve regarding the path of future interest rate increases. Over 80% of industrial companies have exceeded earnings expectations so far for this earnings season with surprising resiliency in short-cycle growth. Organic growth for the major industrials topped expectations at over 6% revenue growth for the quarter, an acceleration from earlier in the year. While outlooks for 2019 were cautious, forecasts were still for decent revenue growth of 3%-5% on average, in line with reduced expectations.
Earnings for the quarter were boosted by continued robust growth from the US despite the recent significant pullback in the ISM manufacturing index. China continues to decelerate, but growth here was basically in line with muted expectations. The impact from tariffs seems minimal at this point, but we caution that company guidance for 2019 does not include any acceleration in tariffs from these levels. China trade negotiations was cited by many companies as a major watch item in the near-term and we see it as the major risk to the sector this year. There was also no discernable impact from the US government shutdown in January.
Europe was clearly the weakest region with close to zero growth for many companies as the Eurozone economy appears to be much closer to recession in recent months. Global PMIs have been slowing, but are still broadly in expansion territory (Fig 1), also in line with recent company outlooks. The hope for China is that its recent stimulus and a potential trade deal with the US will help re-ignite growth in that region.
The industries that have been strong all year remained strong with aerospace, defense, non-residential, oil & gas, railroads and automation leading the way. Automotive was an area of consistent weakness along with semiconductor- related demand. Aerospace was clearly the strongest industry for the sector with company commentary highlighting very strong demand combined with improved execution within the supply chain. Supply chain pressures among engines and structures were an increasing concern throughout 2018, but companies have adjusted to higher levels of production and appear set for further anticipated production increases by the manufacturers in 2019. Aerospace aftermarket demand was also again strong in the fourth quarter due to upgrades and continued high spare parts consumption from above- normal air traffic growth.
Author: Giovanni Staunovo, Analyst, UBS Switzerland AG
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