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The caution that reigns this year for U.S. industrial companies is under attack.
Tuesday, Morgan Stanley analysts and strategists said investors had gotten too pessimistic on industrials and on makers of electrical equipment as they upgraded the firm's investment ratings on the sector. They predicted that strong orders and other positives will push the stocks to outperform the S&P 500 this year.
"We now see substantially more upside for industrial stocks than the overall S&P, driven by sharply rising order books, structural cost improvements, rational global pricing" and government stimulus, wrote the analysts led by Scott R. Davis. They upgraded individual investment ratings on Caterpillar Inc. (CAT) and two other companies, and were joined by the firm's equity strategists, who said earnings expectations have gotten too low, "particularly in the U.S."
The analysts zeroed in on orders for industrial equipment. "Sharply rising" orders are so outpacing earnings that stronger results should arrive a few quarters ahead of schedule, they argued. The comments put Morgan Stanley out ahead of most other analysts and, notably, ahead of a good many industry leaders.
U.S. industrial executives have taken hard looks at the shakiness of the U.S. recovery and sounded cautious notes on their companies' 2010 prospects. This earnings season, they have noted stronger earnings and other positives but also cited headwinds such as lower capital spending and a lack of clarity about what, precisely, is driving demand.
On the rosier side is General Electric Co. (GE) Chief Executive Jeff Immelt, who said last month that the company's environment had improved. But even a relatively upbeat GE doesn't expect to return to growth until 2011.
Others are circumspect, at best. Take industrial-automation product maker Rockwell Automation Inc. (ROK), whose CEO, Keith Nosbusch, predicted late last month that "demand will trend flat to up from here" in the sector. He noted signs of a recovery, but said high unemployment and "very cautious" capital spending were going to be headwinds.
Meanwhile, Wall Street has grown more optimistic, but most firms haven't gotten fully bullish yet.
Perhaps the biggest worry about orders concerns re-stocking after such a long downturn. Companies that spend to replenish their depleted inventories could still face anemic demand themselves. That would mean they have little need to keep buying a few months hence--a "head-fake" scenario the Morgan Stanley analysts call the biggest risk to their predictions.
Other risks of recent note are the threat of Chinese rate-tightening, which could sap demand from a critical market, and the growing concerns over sovereign debt on the periphery of Europe, with worries mounting over the ability of Greece and others to meet their obligations.
Either of those problems has the potential to send shudders through global industrial production under less-than-positive scenarios.
There is much to be learned from coming earnings reports. Among major companies in the sector bearing relevance are Deere & Co. (DE), set to report on Feb. 17 and a key indicator for farm and crop-handling machinery, and Bucyrus International Inc. (BUCY), a maker of mining equipment, which usually reports in mid-February.
Industrial stocks were headed higher Tuesday, with Caterpillar leading the Dow Jones Industrial Average upward as of mid-morning.
The companies Morgan Stanley upgraded Tuesday in addition to Caterpillar were Ingersoll-Rand PLC (IR) and Rockwell Automation Inc. (ROK). Caterpillar was raised to "overweight" from "underweight," and the others to "equal weight" from "underweight." The firm's sector rating on industrials and electric-equipment makers was upgraded to "attractive" from "in-line."
Caterpillar shares were up 5.2% in late morning trading, while Ingersoll-Rand rose 3.1% and Rockwell Automation 2.5%.
-By Brendan Conway, Dow Jones Newswires; 212-416-2670; email@example.com