Machinery & Industrials

We remain extremely cautious on the machinery sector.

As foreign economies deal with weaker exports to the U.S and Europe, industrial customers are cutting back on capital spending. Equipment orders are decelerating in almost every end-market -- from machines used in construction, infrastructure, agricultureto base metal projects.

There are several data points that help to paint the picture of a global slowdown. Japan's core machine orders fell 4.4% in October, and fell in 6 of the first 10 months of the year. What's more, according to the cabinet office in Japan, overseas orders fell a whopping 37.2% in the same month. In November, Japanese industrial production fell 8.1% sequentially, and 16.2% y-o-y.

Also, according to the VDMA machine makers association, German plant and machinery orders fell in October, with a decline in export orders.

When looking at the macro backdrop for industrial production and machinery orders, we expect to see a continued slowdown in capital spending.

OPPORTUNITIES

While the credit crunch and slower economic growth dampens private sector spending, fiscal expenditures appear ready to play a counter-cyclical role. China announced a rather large stimulus package in November.

Also, we expect the U.S government to pass a stimulus package in 2009, as well. The recent rally in certain construction-machinery stocks has likely been in anticipation of higher U.S public infrastructure spending by the incoming administration.

There may be a silver lining amid the current economic slowdown. Central bankers have gone from raising interest rates and fighting inflation to slashing rates and flooding the system with liquidity. These monetary conditions may eventually help to stabilize commodity prices. We would become more constructive on stocks such as Freeport McMoRan ( FCX - Analyst Report ) , on signs reflation measures were working their way into the real economy.

WEAKNESSES

We remain cautious on the U.S residential construction (& related) space. In our view, there is still too much existing and new home inventory to justify a new up-cycle in starts, which partially impacts the order flow of machinery companies that sell or lease equipment to the homebuilders. The weaker labor market and tighter mortgage credit conditions certainly doesn't add to the pool of available homebuyers.