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Industry Outlook

Industrial machinery stocks have been strong performers since the November 8th election, reflecting expectations of increased infrastructure spending and other growth-friendly policies from the new administration. While these stocks have lost ground since the March 1st peak, they are holding on to most of their post-election gains.

The Zacks Industrial Products sector is up +9.6% since November 8th, outperforming the +8.4% gain for the S&P 500 index in that same time period. The sector has lagged the broader market this year, with the underperformance becoming more pronounced since March 1st. The top five gainers this year include Kennametal Inc. (KMT - Free Report) , Rockwell Automation Inc. (ROK - Free Report) , Parker-Hannifin Corp. (PH - Free Report) , Graco Inc. (GGG - Free Report) and Lincoln Electric Holdings Inc. (LECO - Free Report) . The poor performers include Mueller Industries Inc. , Hillenbrand Inc. (HI - Free Report) and MRC Global Inc. (MRC - Free Report) .

Industrial production is one of the leading economic indicators for the industrial stocks. It measures the level of output of manufacturing, mining and utilities sectors in a country.  A brief discussion on the machinery industry in different nations is given below.

Industrial Machinery by Nation

The United States: The country’s industrial production in January grew 0.1% year over year while increasing 0.4% in February, driven by improvements in manufacturing and mining outputs, partially offset by fall in utilities outputs.

New export orders for the U.S.-manufactured machinery have risen 2.9%, according to the U.S. Census Bureau report released in Apr 2017. However, a 0.2% fall has been recorded in export demand for machinery in first two months of 2017 due to a decline of 5.3% in shipments of construction machinery, 22.4% in mining machinery and 1.1% in industrial machinery.

Also, the job market showed improvement in the first three months of 2017, as the unemployment rate declined from 4.8% in January to 4.5% in March. Job additions were 98,000 in March while average job addition in the past three months was 177,667. Citing improvement in economic activities, the Federal Reserve raised its interest rates in March. This, in turn, will make capital investments more expensive and hence might weigh on businesses for industrial products makers.

Per its Jan 2017 report, the International Monetary Fund (IMF) increased its growth projections for the U.S. economy by 10 basis points (bps) to 2.3% for 2017 and 0.4 bps to 2.5% for 2018.

Japan: According to the report from Japan’s Cabinet Office, core machinery orders (an indicator of capital spending by companies in the next six to nine months) increased 0.3% in fourth-quarter 2016 while is anticipated to grow 1.5% in first-quarter 2017. Orders from manufacturing clients are predicted to grow 9.7% while the same from the government clients are expected to increase 2.9%.

As revealed, core machinery orders declined 3.2% in January.

The country’s economy is struggling with internal issues including low investment levels, unfavorable exchange rates, aging population and a huge public debt. Also, the consumption level has failed to revive to a satisfactory standard since it suffered from a 3% rise in national sales tax in Apr 2015.

In addition, the country is facing weak economic conditions externally. However, efforts to improve wages and hence, demand as well as to increase investments domestically and fight deflation might work in the country’s favor in the quarters ahead.

The IMF increased its growth projection for the country by 20 bps to 0.8% for 2017 while it remained stable at 0.5% for 2018.

China: China’s GDP grew +6.9% from the year-earlier period in Q1, coming in better than expected. Though the country is still struggling with capital outflows and forex issues, a slight improvement in infrastructure investment, retail sales and higher oil prices have worked in its favor.

In the first two months of 2017, the country’s industrial production increased 6.3% year over year, above 6% recorded in December. The increase was driven by an improvement in manufacturing and utilities sectors, offset by weakness in the mining sector.

For 2017, the Chinese government anticipates economy to grow roughly 6.5%. The IMF projects the Chinese economy to grow 6.5% in 2017 and 6% in 2018.

India:The country’sindustrial production in Jan 2017 increased 2.7% year over year, as against a decline of 0.1% registered in the previous month.

Expectations of a strong demand, improved policies and better monsoon conditions are the factors that will influence the country’s growth, going forward. The government is making concerted efforts to turn the country into a prime manufacturing hub for all nations across the world. Apart from boosting the foreign capital inflow in the country, these strategies will improve the domestic job market as well as demand for industrial products.

According to the IMF, the country is projected to grow 7.2% in 2017 and 7.7% in 2018.

Brazil: In 2016, the country suffered from adverse impacts of low private investments, inadequate infrastructure, mounting unemployment, high interest rates and political uncertainties. For the quarter ended Feb 2017, the country’s unemployment rate was 13.2%, higher than 11.9% in the three months ended Nov 2016. Also available data reveals that the country’s industrial production fell 0.8% year over year in Feb 2017.

The IMF expects the country’s output to inch up a mere 0.2% in 2017 and 1.5% in 2018. The recovery is dependent on foreign direct investments and expansion of industries like tourism, steel and electricity.

Eurozone: Industrial production in the Eurozone declined 0.3% in February from the prior month while rising 1.2% year over year. The unemployment rate was 9.5% in February.

The IMF predicts output growth in Euro Area to be 1.6% in 2017, up 10 bps over the previous forecasts and grow 1.6% in 2018

Zacks Industry Rank

According to the Zacks Industry classification, Machinery is broadly grouped under Industrial Products, one of the 16 broad Zacks sectors. The Zacks sectors comprise 265 industries that are ranked on the basis of the earnings outlook of constituent companies in each industry. To learn more visit: About Zacks Industry Rank

As a rule, top 50% industries of all Zacks industries outperform the bottom half by a wide margin. Going by this rule, industries with Zacks Industry Rank of 132 and lower would fall in the top half while those with Zacks Industry Rank of 133 and higher would be in the bottom half.

The machinery industry is sub-divided into nine industries at the expanded level: machine tools and related products (carrying a Zacks Industry Rank of 11), construction and mining (26), electrical utilities (4), electronics (79), farm (26), general industries (99), material handling (56), print trading (114)and thermal products (4).

Going by the Zacks rule, we see that the sub-industries of industrial machinery industry fall in the top half. These sub-industries can be of interest to investors seeking exposure in the machinery industry.

Earnings Trend of the Sector

As per the Zacks Earnings Trend report dated Apr 6, roughly 4.5% of industrial products stocks (accounting for 2% of the S&P 500 index’s total market capitalization) in the S&P 500 Group reported results for the Jan–Mar 2017 quarter, recording growth of 4.3% in earnings and 5.3% growth in revenues. In the quarter, earnings and revenues of industrial products stocks are predicted to rise by 5.8% and 7.3%, respectively.

Moreover, results of all S&P 500 companies released through Apr 6 showed 14.5% growth in earnings and 5.1% rise in revenues. In the January–March quarter, earnings for the S&P 500 companies are projected to grow 6.5% and revenues are expected to rise 6.3%.

Conclusion

The IMF anticipates the world economy to grow 3.4% in 2017, including 1.9% growth for advanced economies and 4.5% growth for emerging nations. With the ebbing impacts of prevalent uncertainties globally, the world economy is projected to grow 3.6% in 2018, including 2% growth for advanced nations and 4.8% improvement for emerging countries.

In the quarters ahead, we believethat governmental policies encouraging better trade relations, increase in infrastructural investments, job creation and high consumer-end demand will support growth for industrial machinery stocks. It will be interesting to watch the activities of companies, with at least $20 billion market capitalization, including Illinois Tool Works Inc. (ITW - Free Report) , Parker-Hannifin Corp., Ingersoll-Rand PLC (IR - Free Report) , Fortive Corp. (FTV - Free Report) and Rockwell Automation.

In the S&P 500 group, a major machinery company is Deere & Company DE. It has a market capitalization of $35.4 billion and currently sports a Zacks Rank #1 (Strong Buy).The company’s long-term growth prospects seem bright on the back of increasing population, rising living standards, investments in new products and expansion in unexplored geographies. In the next three to five years we anticipate earnings to grow 7.58%.

Roper Technologies, Inc. (ROP - Free Report) also sports a Zacks Rank #1. Its earnings are predicted to grow 12.33% in the next three to five years.

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