From the July investment comments of Provident Investment Management
After 10 years of mostly steady expansion, the industrial economy currently looks tired. Transportation, energy, and basic materials stocks have been among the market’s worst performers in the past one and three months. The statistics confirm investors’ concerns. April’s industrial production estimate showed annualized growth of less than 1%, about half its previous pace. In May, the manufacturing Purchasing Managers’ Index (PMI) logged its worst monthly reading since 2009. Statistics are noisy estimators, but it would be nearly impossible to generate data that bad purely by chance.
Yet nonindustrial indicators continue to hold up. Retail sales and consumer spending are advancing steadily. Consumer confidence, surveyed by the University of Michigan, remains strong. Measured unemployment is just 3.6%. A slowdown in the economy’s industrial “engine” would have signaled a wider recession historically, but the industrial cycle just doesn’t seem to matter like it once did. The American worker and consumer is doing just fine thanks, steel or no steel. …
… Stocks have rapidly recovered almost their entire decline from May. Further gains may rest on the uncertain outcome of the impending Q2 earnings season. Analysts are not very enthusiastic. According to the most recent Earnings Insight, authored by FactSet’s John Butters, S&P 500 companies anticipate aggregate earnings to decline 2.5% year over year. The good news for growth investors is that these declines will be highly concentrated in the materials sector. The other trouble sector is technology, where the trade war’s supply chain disruptions will be the most acute.
Stock prices can be decomposed into an earnings component and a valuation component. Valuations are affected by interest rates and global macroeconomic forces. The earnings component is specific to the company, however, and we always advocate for companies with the ability to grow earnings and, over the long run, to effectively write their own ticket to stock price appreciation.