The sector’s results for the first quarter and going forward may surprise investors who overlook the underlying core strengths of many financials firms. And, given how beaten down the sector has been, it might not take much in the way of positive news for these stocks to make meaningful moves higher.
The large, multinational companies that make up the industrials sector have been hurt recently by relatively slow global economic growth and the rallying U.S. dollar. When the dollar rises in value versus other currencies, it makes U.S. products sold overseas more expensive—tamping down demand for those products. Investors have expected the worst for industrials in the face of those headwinds.
Recently, however, the dollar has begun to weaken. In the first quarter, for example, it fell by around 5% versus the euro. This decline is being driven in part by the Fed’s decision to remain “on hold” and cautious about raising short-term interest rates. (When rates rise, the dollar rallies—and vice versa.) At the start of the year, most investors were looking for four Fed rate hikes. Now, however, there will likely be just two—and maybe less.
The falling dollar trend isn’t having a major impact on first quarter earnings because it began too close to the end of the quarter. But it could very well act as a tailwind for the industrials sector’s results going forward—an outcome that many investors don’t yet fully appreciate, as evidenced by valuations in the industrials sector (17.8 versus 19.3 for the S&P 500). The indication that foreign central banks are moving away from currency manipulation as a method to boost their economies is another positive sign that the recent “weak dollar” trend is becoming more entrenched.
In addition, industrials have done a good job at cleaning up their balance sheets in the past year or two, and of getting their cost structures in line. As the sector starts to regain pricing power, much of that additional revenue should fall right to the bottom line.