Concerns about the state of the U.S. economy finally caught up to industrial stocks—but the sector still looks like it could be one of the big beneficiaries when the U.S. economy finally reopens.
It was a bad week for industrial stocks. The Industrial Select Sector SPDR exchange-traded fund (ticker: XLI) fell 0.9% this past week despite strong industrial production data on Friday, which showed a rise of 1.6%. But industrials really haven’t been the “It” sector for quite a while now. After surging 20% from Oct. 28 through Nov. 24, the Industrial ETF has been trading virtually sideways, dipping 0.5% through Friday’s close.
Still, it’s not time to give up on the sector. Low levels of inventory should support manufacturing, even amid the latest shutdowns. And economic activity should start picking up again in the next few months as people get vaccinated and relief checks hit consumer bank accounts, with more stimulus perhaps to come. What’s more, a weak dollar should also provide a boost.
“With domestic goods demand still elevated, inventory levels still looking very lean and the dollar weakening, the immediate outlook for the sector remains upbeat,” writes Capital Economics’ Michael Pearce of industrials.
Government handouts aren’t the only stimulus payments that will be hitting the economy in 2021. Jefferies strategist Sean Darby notes that the cash-to-asset ratio for S&P 500 companies, excluding financials, is at around 8%, near its highest level on record. That money will get spent—it’s just a question of where.
Buybacks are unlikely given the optics of repurchasing shares during a pandemic, Darby explains, so companies will be more likely to fund capital spending and research and development. And the money they spend will hit the economy at the same time as government and consumers open their wallets, providing a boost to industrials, among other sectors. “One of the unique features about this cycle is that every single balance sheet—government, household, corporate—is spending at the same time,” Darby writes. “This is extremely rare post a ‘credit shock.’”
But there’s a more immediate catalyst for industrial stocks—fourth-quarter earnings season. Consensus estimates are for earnings to drop 5.4% year over year for the roughly 100 industrial and chemical companies tracked by UBS strategist Ajit Agrawal, while the firm expects revenue to drop by just 0.3%. Its forecasts are based on macro data, including the price of the U.S. dollar, which fell during the fourth quarter and should provide a tailwind. Companies set up for a sales beat include Stanley Black & Decker (SWK), Illinois Tool Works (ITW), and Snap-On (SNA), the data show.
Investors looking to make a bet on an industrial bounceback could do worse than buy 3M (MMM). While it’s known as the maker of Post-it Notes, Scotch tape, and Ace bandages, 3M makes the adhesives, abrasives, and chemicals companies need to do what they do. Its stock has dropped 7.9% over the past 12 months, even as the Industrial Select Sector SPDR ETF has gained 6.3%. Wall Street is equally lukewarm on the company, with 72% of analysts rating the stock an equivalent of Neutral, and with more Sell equivalents than Buys.
Analysts have a good reason for shying away from 3M. The company has exposure to legislation regarding per- and polyfluoroalkyl substances, or PFAS, contamination. Although 3M quit using the chemicals in the early 2000s, it could be held accountable for water contamination. That risk is particularly high now that the Democrats are set to control both houses of Congress.
That was the reasoning when Bank of America’s Andrew Obin cut the stock to Underperform from Neutral on Jan. 7. “We believe Democratic control of the relevant Senate Committee and the EPA will accelerate strict legislation on PFAS,” Obin wrote.
But with 3M scheduled to report earnings later this month, the stock could be set for a move higher. Deutsche Bank analyst Nicole DeBlase put a short-term Buy rating on the stock this past week, noting that 3M looks set to not only beat fourth-quarter earnings forecasts but to offer above-consensus guidance for 2021 as well. She expects 3M to forecast earnings of $9.55 to $9.85 for the year, better than expectations for $9.49. That, combined with the fact that hate for 3M is running high, sets the stock up for a nice move higher following its earnings report.
3M might also be setting up for a breakout to the upside, according to Phases & Cycles technical analyst Monica Rizk. The stock had been in a steady downtrend since peaking at $229.29 in February 2018, a trend that accelerated with the coronavirus meltdown. Since bottoming in March, however, 3M stock has broken that downtrend—and breached its 40-week moving average to the upside. Support now sits in the $158 to $160 range, with the next resistance level at $180.
If 3M can break through resistance, it could trade as high as $210, Rizk writes, a 27% rise from Friday’s close of $165.55.
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