War in the Gulf Again Imperils Factory Sector

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Maybe the handwriting was on the wall. In the last war with Iraq, the economy came to a virtual standstill, with industrial production declining steadily from September 1990 until March 1991, when it hit bottom, falling nearly 4% year over year.

We probably shouldn't be surprised, then, to find that manufacturing activity seems to be grinding to a halt during Iraq redux as well. The anecdotal data, no matter how volatile or reliable, aren't particularly encouraging. February new-home sales plunged 8.1% to their lowest level since August 2000. Durable goods orders for last month were also weak, falling 1.2%, or 2.7% if you exclude strong results in the defense sector.

With the travel industry paralyzed and airlines in financial distress, it's no secret that the commercial aerospace market is in a deep recession. And when auto sales are released next week, there probably won't be much to get excited about there, either. Usually, this would mark a good time to be buying industrial stocks, which have fared poorly relative to the overall market for quite some time. Many now trade at attractive valuations, particularly for longer-term investors.

But don't be surprised if we see another 10% to 15% pullback -- down to the October lows -- because that's where the stocks would trade using the historical low price-to-earnings ratios applied to the low or "worst case" estimates on Wall Street for this year.

Better Days

Surely the worst performance for the sector is behind it. Over the last 52 weeks, the Dow Jones Diversified Industrial Index is down 28%, compared with a 22% decline in the market overall. The underperformance picked up speed in the first three months of this year as war became more likely. Shares of industrial stocks such as Honeywell (HON Quote), Ingersoll-Rand (IR Quote), Emerson (EMR Quote) and Parker-Hannifin (PH Quote), for example, are all down between 5% and 10% year to date, compared with just a modest decline for the market overall.