Industrial stocks look underpriced and the coronavirus impact on economic growth may be more than offset by other factors. - TheStreet

Worried About Coronavirus and Stocks? Watch the U.S. Industrials

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The coronavirus has had its way with the U.S. stock market to start 2020. That’s the bad news.

The good news? Finding stocks that are less affected isn’t that hard and U.S. industrials could be one such group.

Industrials have seen considerable upward revisions in earning estimates, while their stock prices have lagged the broader market.

And while the coronavirus outbreak will hurt revenue in China, other factors may outweigh that negative.

The S&P 500 is up 0.7% so far this year but is down 2.3% since Jan. 17, in what some strategists are calling the beginning of a rather benign correction.

Stocks rose on Monday, with the S&P 500 up 0.86% and no new negative developments on the virus emerging.

The coronavirus has worsened since the initial reports. In China it has killed more than 360 people and infected more than 17,000, the New York Times reports.

As an economic matter, Goldman Sachs economists see the virus outbreak cutting GDP growth in the country by roughly 0.4 percentage point for 2020.

U.S. companies with significant China exposure are seeing an outsized down move in their share prices. Starbucks SBUX, Nike NKE and Canada Goose GOOS are down 8%, 4.5%, and 10%, respectively.


Analysts say Apple AAPL and chipmakers that have plants in China may halt production, hurting sales.

Enter U.S. industrials.

Pricing-Optimism Discrepancy

First, U.S. industrials have seen their earnings revised upward of late, but their share prices may not have reflected that optimism.

“Industrials’ relative revisions have started to turn up while performance has lagged, suggesting a potential price catchup if relative earnings momentum continues,” Morgan Stanley Equity Strategist Michael Wilson wrote in a note.

His chart showed that estimates of forward-12-months earnings per share for industrials have been revised upward by roughly 5 percentage points in the past few months. Meanwhile, the iShares Industrials U.S. ETF IYJ is up almost 3% in the past three months, less than half the S&P 500’s gain of 6.12%.

Caterpillar CAT is expected to see earnings contract in 2020, but each quarter should see steady improvement on the company's rolling one-year outlook. CAT’s 2021 expected EPS of $10.62 represents growth of 11% over 2020 estimates.

U.S. manufacturing activity has been contracting on a year-over-year basis since August, but it’s expected to soon rebound. Caterpillar shares are down 10% in the past three months. The stock also trades at a forward earnings multiple of just below 12, compared with the S&P 500’s average of 18.3.

Another example: United Technologies UTX is expected to see its 2020 earnings come in roughly flat with 2019, but then grow almost 13% in 2021. The stock is up just 2.5% in the past few months and trades at 16 times forward earnings.

The uptick in U.S. stocks in the past three months has been driven by upward revisions to GDP estimates and the Federal Reserve’s promise to keep interest rates low, both of which benefit industrials.

But tech stocks have again charged ahead. Analysts have revised higher their estimates of 5G-device demand, driving hardware stocks. Big techs like Microsoft MSFT and Apple AAPL have posted strong results with their diversified and growing earnings streams.

Lower rates can often benefit growth stocks more than value stocks, as a lower discount rate to the riskier growth equity market boosts valuations higher than for value stocks. 

The S&P 500 growth index is up 6.5% in the past three months while the value index has eased 1.6%.

Coronavirus vs. Competing Factors

But shouldn’t the coronavirus hurt revenue that large industrials derive from China?

Yes, but consider offsetting factors. Caterpillar, United Technologies and large-cap engine manufacturer Cummins CMI all get at least 5% of their revenue streams from China.

But Morgan Stanley’s Wilson reminds investors that “any opinion about how long lasting the impact [of the virus] will be must take into consideration one’s view on how strong the recovery was in the first place.”

He notes that U.S. GDP growth is trending at above 2% for 2020, a tick higher than 2019’s 2.1%, and that the rate of global GDP growth is expected to stop slowing. Emerging-market GDP is expected to grow at a strong clip, with much of that attributable to China.

In addition, monetary policy from the Fed and China are also continuing to support growth with liquidity.

These factors might just overpower the impact of the coronavirus.