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An Industrial "Upgrade" Cycle Arrives: Zacks May Strategy

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The following is an excerpt from Zacks Chief Strategist John Blank’s full May Market Strategy report. To access the full PDF, click here.

One highlight in the May 2018 Zacks Market strategy report is the sudden dominance of Industrial spending.

The Industrial Products sector is currently placed at the top 6% out of the 16 Zacks sectors. It is one of the sectors expected to record double-digit earnings growth, mainly driven by U.S. tax reform. According to our latest projections, the sector is anticipated to log an earnings growth rate of +25.8% in the first-quarter of 2018, on the back of a +12.8% rise in revenues.

Earlier this year, an Equipment Leasing and Finance Foundation report focused on the $1T equipment leasing and finance industry. It highlighted the breaking trends.

Investment in equipment and software is projected to expand +9.1% in 2018.

That 2018 investment growth projection is well above the +5.2% growth rate experienced in 2017.

It continued a strong improvement trajectory seen over the last 12 months.

While a few headwinds persist, they should be outweighed by an encouraging business investment climate.

In addition, an upbeat outlook for industrial companies — such as defense contractors, building products and machine makers — is a bet on continuing global economic revival.

Stronger growth around the globe means companies spend more on new machinery, see increased cargo demand on railroads, and profit from an increased pace of automation.

Internally, U.S. corporations must spend more to replace aging equipment and tech systems. The age of equipment in the U.S. remains at all-time highs and desperately needs to be replaced. This so-called “upgrade” cycle is creating a boom for industrial companies.

What about the money to finance the spending? It comes from the new lower 21% corporate profit tax that stronger U.S. and global economy and an internal change in U.S. tax rules. This change will allow companies to take a deduction for the full value of new plant and equipment upon purchase, rather than stringing it out over a number of years.

Every four years, the American Society of Civil Engineers issues a report card on the condition of the nation's infrastructure. In 2013, the country received a sad D+. The 2017 report card was no better – another D+.

Clearly, the need for a U.S. infrastructure overhaul had been there. But what exactly did that mean, who pays for it, and how much should be spent?

That Society of Civil Engineers Report Card had put up many questions and few answers.

It appears, until now.

Zacks May Sector/Industry/Company Telescope

May Zacks Industry Ranks showed a very important change. Industrials are the leader. With U.S. unemployment so, so low, the demand for machinery of all types is high and construction is booming.

Other sector leaders were the most exposed internationally: Info Tech, & Materials. That growth trend cooled a bit, though.

The Consumer Discretionary and Consumer Staples sectors fell to Unattractive. There appears to be a Late Cycle struggle to expand spending on a number of categories. The +1.1% U.S. consumer growth rate in Q1 was picked up here.

Four May sectors stood at a Market Weight: Energy, Health Care, Financials, and Utilities. Telcos lingered at the back and was Unattractive.

(1) Industrials are now Very Attractive and rising Machinery profits show how tight the labor market is. A long list of industrial groups looks HOT it includes Machinery-Electrical, Machinery, and Industrial Products-Services, Business Services, and Construction-Building Services, and Aerospace & Defense.

Top Zacks #1 Rank (STRONG BUY) Stock: Harsco Corp. (HSC - Free Report)

Harsco is a services and engineered products company. The principal lines of business are: mill services that are provided to steel and non-ferrous metal producers; gas control and containment products; scaffolding services; railway maintenance of way services and equipment; and several other lines of business including, process equipment, industrial grating and bridge decking, industrial pipe fittings, slag abrasives and roofing granules.

(2) Info Tech is merely Attractive in May. The best is still the Semiconductors.

Top Zacks #1 Rank (STRONG BUY) Stock: KLA-Tencor (KLAC - Free Report)

KLA-Tencor was formed through the merger of KLA Instruments and Tencor Instruments, two long-time leaders in the semiconductor equipment and yield management software system industry.

(3) Materials are back to just Attractive too. The best are Paper and Steel.

Top Zacks #1 Rank (STRONG BUY) Stock: Grupo Simec SA de DV

Grupo Simec, S.A, de C.V. is the leading mini-mill steel producer in Mexico and manufactures a broad range of non-flat structural steel products and is also among Mexico's lowest cost producers of extruded aluminum products.
(4) Energy is a Market Weight. The best is Coal and Oil & Gas Integrated.

(5) Health Care is a Market Weight. The Drugs and Medical Products industries are best.

(6) Financials are back to a Market Weight. The best is Investment Funds and Investment Banking & Brokering.

(7) Utilities are a low Market Weight.

(8) Consumer Staples falls to Unattractive. The best 2 industries are Food and Beverages, and those are just Market Weight.

(9) Consumer Discretionary falls to Unattractive. The top industry is Publishing. Far behind are Leisure Services, Non-Food Retail, and Apparel.

(10) Telcos are Unattractive.


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