This week, we reintroduce our volatility charts and here we highlight the inverse correlation between volatility and valuation. We also touch on GE and the fresh, old claims around its accounting.
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The risks remain in the distributor channel with inventory trends at cycle peaks - electrical, chemical, MRO and Big Box stand out to us. Manufacturers remain in better shape, although A&D, Auto, Chemicals and Semi sectors are carrying excess inventory. Generally, we see channel burn as a risk to short cycle demand into 1Q20, compounded by increasing sell-out weakness. EE/MI stocks with greatest leverage to external channels are 3M, SWK, ROK, RBC, HUBB and ITW; GE and UTX are least exposed.
Folks – I wanted to send you a complete and up to date compilation of our models post-2Q19 results. Our Model Book also includes cheat sheets and bull/bear target price spreads for each company.
We are in the middle of the Atlantic hurricane season, and we can't help but draw a parallel with the economic slowdown and associated China trade conflict that is buffeting industrial demand. Capital spending has flattened out for FY19, and the outlook for the US over the next 6-12 months has significantly deteriorated. Global capex spending remains relatively depressed vs. history, which likely limits 2020 downside risk, and offers continued hope of recovery in a more stable macro backdrop.
This feels like a very different environment. Global PMIs are sub-50 – a bullish indicator for Cap Goods stocks – yet trade tensions are ratcheting substantially higher, valuations are too rich and we have yet to see a negative EPS revision cycle in the US. This all argues for a more defensive profile.
WR CGMI declined 2.7ppts M/M to 44.9 in July, on weakness in China and ROW regions. This confirms the negative trend that has been in place since May, immediately after trade talks first broke down. Since cap goods momentum has been so sensitive to trade, the announcement of List 4 tariffs is a troubling development. Further negative momentum would be bearish for the EE/MI group and this endorses a more defensive and less pro-cyclical bias to portfolio positioning.
WIW 605: This week we highlight that inventory levels continued to grind higher during 2Q19. This, along with the imposition of List 4 tariffs, places significant risk to the 2H set-up. The market has been re-rating short cycle laggards, but we think this trade could reverse in a risk-off market.
This week, we take another pulse check on 2Q19 earnings season, and publish updated thoughts on the last four of our coverage through the gate, namely GWW, ROK, MMM and FTV. Ironically, these names with the exception of FTV, have been the best performers since our earnings preview on 9 July and it is no coincidence that these were popular HF shorts. Yes, positioning has been a much greater factor this quarter.
It feels like the market is rewarding industrials more for margin execution this quarter, with less emphasis on demand dynamics, per se. Generally, the market is selling reports, but we continue to like UTX, IR, EMR, GE and JCI as tactical longs.
The early reads for Europe point to ~2ppts of core sales deceleration Q/Q, which is broadly in line with expectations with solid execution, offset by Industrial demand deterioration, while global construction appears to be a relative safe harbor; autos and electronics remain major areas of risk, but very known and visible. The issue is visibility around demand recovery, with 3Q setting up as another challenging quarter.
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