“I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.”
I don’t have the foggiest idea if Abraham Maslow, the psychologist who authored that quote back in 1966, knew anything about investing.
But from painful personal experience I’d propose an investing version that goes like this: “When you only know one group of stock, it’s tempting to see that group as the way to succeed in every market.”
In 2011 I think it’s going to be very hard to make much money in the stock market unless you learn a new stock group, one that you’re possibly uncomfortable with, and one that’s not the commodities or technology stocks that you’re familiar with from the last two huge rallies.
You’re going to have to learn something about industrial and manufacturing stocks. That’s the stock group you’ll need in 2011—or at least in the first half of 2011.
(My Dad told me his own version of Maslow’s quote one day when he handed me a pipe wrench and said “When every problem is a nail, you should use just about anything you have as a hammer.” But I don’t know what the investing wisdom in that might be.)
In 1999, for example, anyone who knew technology stocks hammered the stock market for about a 100% gain. Or more. Shares of Cisco Systems (CSCO) climbed 131% that year.
Try that in 2007, a huge rally year like 1999 that preceded a crash, and you would have been left crying on your router. Shares of Cisco dropped that year by about 1%. Not every technology stock did that badly in 2007. IBM (IBM) was up 13%. Microsoft (MSFT) advanced 21%. Oracle (ORCL) nailed 32%. Intel (INTC) 34%.
But compare those gains to those delivered by a completely different stock group. General purpose mining stock BHP Billiton (BHP) was up 79% in 2007. And BHP Billiton would have been a lagging mining pick that year. Brazil’s iron ore giant Vale (VALE) climbed 122%. Potash of Saskatchewan (POT) soared 202%.
Yep. In 2007 it sure would have paid off to abandon what you know—technology stocks–and learn an unfamiliar group—commodity producers.
In 2011, I’d argue, that group you need to know is industrials.
First, because that’s where we are in the economic cycle. I think we’re in the early recovery stage of the economic cycle. (For more on why I think that and why it’s important see my January 28 post http://jubakpicks.com/2011/01/28/where-the-heck-are-we-in-the-economic-cycle-anyway-the-answer-is-important-in-deciding-what-sectors-to-overweight/ .) In the early recovery stage consumer sentiment improves, industrial production turns up, interest rates hit bottom, and unemployment peaks and starts to move lower. Sectors that do best are usually industrials, near the beginning of the stage; basic materials; and, near the end, energy.
Second, the actual economic numbers, as opposed to the economic theory, say that manufacturing is leading the economy at this point in the cycle. (For more detail see my post on February 2 http://jubakpicks.com/2011/02/02/u-s-manufacturing-growth-accelerates-will-job-growth-follow/ .) The ISM Manufacturing Index climbed to 60.8 in January from 58.5 in December. The January number was the highest since May 2004. New orders picked up to 67.8 from 62.0 in December. The order backlog index rose for the first time since August 2010 to 58.0 from 47.0 in December.
And the U.S. economy isn’t the only one in the world with strong manufacturing activity right now. In the United Kingdom, despite a contracting economy, manufacturing grew at a record rate in January, and from China, where a purchasing managers index from HSBC and Markit Economics climbed to 54.5 in January.
Third, this outperformance by manufacturing makes sense. During a recession, especially during a deep recession, companies put off any spending they can—especially any spending that’s linked to increased production capacity. Why invest in new plant and equipment when the old stuff is only running at 60% of capacity or less?
When the turn in the economy comes—or at least when companies are convinced that the turn is real—they move to buy. And they buy not just for their current needs but to make up for all the buying that they postponed during the recession.
So, for example, sales of Class 8 trucks—the big rigs—fell well below the long-term replacement rate during the Great Recession. No operator or owner wanted to sink money into a new truck when nobody knew if there would be freight to haul tomorrow. The result was that by the spring of 2010 the age of the U.S. fleet has reached a two-decade high. The orders that started to flow in to Cummins, Paccar (PCAR), and other truck makers and suppliers in the second half of 2010 included a huge dose of pent-up demand.
You can see the same thing in radically different industries. Mining companies have announced huge increases in capital spending budget as they run to catch up with demand. Rio Tinto (RIO), for example, has announced that its capital spending will climb to $11 billion in 2011 from $4 billion in 2010. In the semiconductor industry Intel has announced that it will spend $9.3 billion on new plants and equipment in 2011, a 79% jump from 2010. Chipmakers as a whole will spend $42.2 billion in 2011, up from $38.4 billion in 2010, according to research from Gartner.
Okay, so let’s say you’re convinced by this and that don’t know a diesel from a weasel or a think that BHP Billiton makes billabongs, whatever they are. How do you teach yourself enough about an unfamiliar group of stocks and fast enough to profit before the economic cycle turns to another group?
First, start with what you do know and use that as an entry into the unfamiliar.
Say you’re familiar with companies such as Intel and Advanced Micro Devices. That ought to give you a head start in researching the industrial companies that make their production equipment such as Applied Materials (AMAT) or ASML Holdings (ASML). (And it should help that ASML Holding is a member of Jubak’s Picks http://jubakpicks.com/the-jubak-picks/ and that I updated the stock and the semiconductor equipment sector on February 3 http://jubakpicks.com/2011/02/03/update-asml-holding-asml-3/ .)
Or if you’re a commodities investor, it should be a relatively easy leap to the companies that make the tools—the great big tools—that mining companies use. And that will take you to companies such as Joy Global (JOYG), Caterpillar (CAT) and Komatsu (KMTUY) that make that equipment.
What if you’re not an “expert” in any sector (or at least not in one that takes you into an industrial segment)? Well, you consume industrial products everyday. You probably drive a car; you follow the news so you know about the near death experience of the U.S. auto industry; and you’ve bragged or listened to the brag of a friend about a new car. Go from that to the industrial companies that make the turbo chargers that give the current generation of cars more power for less fuel (BorgWarner (BWA)) or the companies that make those neat new rear-view cameras (Gentex (GNTX.))
Second, recognize that you’re not coming into this game early and you’ve got to do some work to catch up with the folks who bought industrials months ago.
So dig down another layer.
Sure, it would have been great to buy JoyGlobal (JOYG) when it was selling for $53.89 a share on August 26, 2010. But absent a time machine (and no, I don’t know the stock symbol for any time machine maker), you’re stuck on February 2 looking at JoyGlobal at $90.29 or 68% higher than back in August.
So how about some names that are less familiar to you?
There’s Titan International (TWI) that makes the wheels and tires for the big trucks and diggers (and for farm equipment too). Whoops, guess that one might be unfamiliar to you but not to industrial sector investors. The shares were up 96% from August 26 to February 2.
How about Timken (TKR), a maker of ball bearings and specialty steels? The shares are up only 50% during that period. Or steel tube maker (for oil drilling) Tenaris (TS) up 41% Or steel-maker Nucor (NUE) up 31%.
Third, don’t limit yourself to the United States. Like Caterpillar? How about Japan’s Komatsu?
And don’t fall back on only the familiar names in overseas markets. If you can name a European industrial stock, it’s most likely Siemens (SI). But Switzerland’s Schindler Holding has the No. 1 position in the global escalator market. (Try to build a shopping center or just about anything else without one. And you know how much maintenance escalators seem to need.) The stock trades in the United States as SHLAF or SHLRF.
My favorites? Here are my top five based on where I think we are in the cycle and their prospects going forward:
Nucor (NUE) because the steel industry lags much of the sector in its recovery.
BorgWarner (BWA) because auto sales in the U.S. have just started to recover.
ASML Holding (ASML) because the war among chip makers is great for chip equipment makers.
Titan International (TWI) because despite its 96% gain from August, the stock still trades at only two-thirds of its 2008 high and the construction equipment market still hasn’t fully kicked in.
Keppel (KPELY) because I’d rather own a company that makes drilling rigs right now than one that owns them. (And Keppel’s water infrastructure business is a gem.)
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Applied Materials, ASML Holding, BHP Billiton, BorgWarner, Cisco Systems, Cummins, JoyGlobal, Keppel, Komatsu, Nucor, and Vale as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/.