The Inflation Cycle of 2002 to 2015 - Uhlmann Price Securities

More documents

Recommendations

Info

Industrial Portfolio Strategy The Inflation Cycle of 2002 to 2015 ⎯ April 19, 2002 -8- Legg Mason Wood Walker, Inc. We expect the PPI All Commodities index to outpace the S&P 500 over the 2002 to 2015 period; we see commodity outperformance particularly strong later in the period. We see single-digit compounded S&P 500 price returns over the 2002 to 2015 period, as the focus shifts from liquidity plus rising P/Es to falling P/Es plus EPS growth driving earnings “power.” Inflation could be made significantly worse if increasing geopolitical instability leads to wars in the 2002 to 2015 period, possibly in the volatile Middle East where pressures are intense. Stock Rating Changes As a result of our research and the preparation of this report, we have upgraded our rating on Caterpillar Inc. (CAT – $54.92), Deere & Company (DE – $43.25), and Joy Global (JOYG – $16.25) shares from Market Performance to Buy, since machinery tracks the relative strength of commodity prices, shown in Exhibit 1. Although none of the stocks appear inexpensive to us on our 2003 estimates, they are Exhibit 1 – The Stock Market Versus Machinery (Black Line) and the Stock Market Versus Commodities (Green Line), 1945 to 2001 - Is this a new, secular bull market for machinery? 3.00 2.50 2.00 Note the red and blue lines of alternating stock market and commodity price leadership correspond to the cover chart of this report. S&P beats machinery and S&P beats commodities 12.00 ? 10.00 8.00 6.00 1.50 S&P beats machinery and S&P beats commodities Machinery beats S&P and Commodities beat S&P 4.00 1.00 2.00 0.50 0.00 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Stock Market Relative to Machinery Stock Market Relative to Commodities Source: U.S. Department of Commerce, Standard & Poor’s Corporation
Industrial Portfolio Strategy The Inflation Cycle of 2002 to 2015 ⎯ April 19, 2002 -9- Legg Mason Wood Walker, Inc. moderately attractive because of their leverage to the environment we expect in the coming years. For example, Caterpillar is the leading provider of engines used in the production and movement of hydrocarbons, as well as the leading provider of heavy machinery used to extract minerals or build basic infrastructure in many emerging markets, a number of which are commodity producers. Deere & Company is the leading provider of farm machinery in the world, and Joy Global has a leading position in electric shovels and underground coal mining equipment. Our posture since 2000 with respect to CAT and DE has been to trade the stocks within a price range until EPS began to recover. Both CAT and DE have performed well since 3Q00, around the same time the price of the S&P 500 began to decline, which we do not believe is coincidental since that is around the same time the secular changes we outline in this report began to emerge. We turned neutral on CAT and DE in December 2001 as a result of macroeconomic “balance sheet” concerns that have since been overshadowed by aggressive (preinflationary?) policy bandages applied to the “cash flow” side of the economy. Exhibit 2 – Machinery Index (CAT+DE+IR+PH) Price Cycles, January 1981 to Present 250.00 200.00 150.00 100.00 50.00 Secular peak Apr. 1981 Trading Range CAT+DE+IR+PH Combined Stock Price Jan-1981 to Present A pull-back is possible, our view. "Cyclical" +150% July 1984 to May 1990 vs. S&P 500 up 140% in the same period. Trading Range "Cyclical" +293% Aug. 1992 to Mar. 1998 vs. S&P 500 up 223% in the same period. Trading Range 0.00 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Source: S&P CompuStat, Legg Mason The machinery stocks have enjoyed a considerable rally since they bottomed in 3Q00, although the group has not yet broken out of the roughly four-year trading range in which it has been locked. As shown in Exhibit 2, if there is “only” a post-recession, cyclical recovery in store for machinery, similar to the July 1984 to May 1990 period (+150% absolute performance and +10% relative to the S&P 500), or perhaps August 1992 to March 1998 (+293% absolute and +70% relative), then we may see a mild pullback before a multiyear recovery begins. As a result, we are keeping some powder dry and deferring a Strong Buy rating until we see lower stock prices or a more sustainable EPS recovery on the horizon, all else being equal. Our greater interest, and the subject of this report, is a secular, long-term story that may be brewing for commodities. Since such a story is tied to the inflation outlook, we are mindful that there may be numerous market dislocations if the inflation mentality changes, and those dislocations may provide lower prices
Page 1 and 2: For a printed copy of this report,
Page 3 and 4: Industrial Portfolio Strategy The I
Page 7: Industrial Portfolio Strategy The I
Page 59 and 60:
Industrial Portfolio Strategy The I
Page 61 and 62:
Page 63 and 64:
Page 65 and 66:
Page 67 and 68:
Page 69 and 70:
Page 71 and 72:
Page 73 and 74:
Page 75 and 76:
Page 77 and 78:
Page 79 and 80:
Page 81 and 82:
Page 83 and 84:
Page 85 and 86:
Page 87:
show all

The Inflation Cycle of 2002 to 2015 - Uhlmann Price Securities

Create successful ePaper yourself

Delete template?

Save as template?