“The industrial environment is in a recession – I don’t care what anybody says, because nobody knows that market better than we do,” stated Daniel Florness, Chief Financial Officer of Fastenal Co. (FAST), on the company’s third-quarter conference call.
The man was adamant, and he had reason to be.
Fastenal doesn’t just sell nuts and bolts to local hardware stores. It provides a wide variety of industrial and construction supplies including power tools, packaging materials, electrical connectors, chemicals, HVAC components, and hydraulic systems.
So, if Fastenal is seeing extreme weakness in its customers’ spending rates, then there’s good reason to believe that the United States is, in fact, suffering an industrial and manufacturing recession.
Of course, others who basically have to be bullish on stocks are saying, “Not so fast.”
To Bias or Not to Bias?
Tobias Levkovich, Chief Equity Strategist at Citigroup Inc. (C), dismissed industrial sector worries on Bloomberg Television last week.
Levkovich noted, “Even if you look at durable goods orders, they have not plummeted 20% to 30% like they’ve done in previous recessions, so every time I hear the words ‘industrial recession,’ I cringe.”
However, we should be wary of his commentary.
Like Wall Street economists, equity strategists basically get paid to tell clients what they want to hear. Their clients own a boatload of equities, so these financial pundits tend to dismiss any and all risks.
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For example, heading into 2008, Levkovich was bullish on financials and had an end-of-year S&P 500 price target of 1675 (equivalent to a 14% gain). The S&P actually lost 38%, and 2008 was the worst year for financials since the Savings and Loan Crisis.
Needless to say, if someone failed to warn about the worst recession since the Great Depression, they’re either biased by conflicts of interest or can’t see the big picture (and it’s probably both).
Currently, the market seems to be listening to utterly conflicted bank strategists rather than heeding the warnings of company executives with boots on the ground.
It’s scary that industrial stocks don’t seem to be “pricing in” even the possibility of an industrial recession, let alone evidence that one has already started.
The price-to-sales ratio (P/S) for the S&P 500 Industrials Index is 1.56 times, as can be seen in the chart below.
At a time when many industrial companies are struggling to grow revenues – as Fastenal can attest – the P/S ratio for this sector is well above its 10-year average.
In the latter part of 2011, recession fears brought the Index’s P/S ratio down to around 1.0 times, but we’re currently nowhere near that valuation level.
Be mindful of your exposure to industrial stocks.
And be wary of the opinions you hear in the financial media. Most “analysts” aren’t trying to get things right. They’re simply sticking to the script that was formulated by a committee within their firm.
Safe (and high-yield) investing,
Alan Gula, CFA