This Sector Just Crashed the Market… Is It an Opportunity?

Matthew Carr By Matthew Carr
Emerging Trends Strategist

Market Trends

Will they or won’t they?

It’s a question that’s kept audiences rapt for generations.

There was Sam and Diane from Cheers

Niles and Daphne from Frasier

Ross and Rachel from Friends

People agonized over whether the couples would… or wouldn’t.

Today, the latest “will they or won’t they” debate has little to do with love. And has a lot to do with animosity.

The couple under scrutiny is the U.S. and China.

And the question is whether the tariffs each country have threatened one another with will ever be introduced… or whether it was just tough talk in the heat of the moment.

For investors, the markets were rattled as the U.S. and China exchanged trade barbs.

The Dow and S&P 500 seesawed.

It was headline anxiety as the media covered one retaliation after another, fueling concerns of a dreaded “trade war.” And as the tariff targets became soybeans, nuts, pork, wine and even crude oil, the uncertainty bled into shares of an industry vulnerable to agriculture disruption…

Heavy equipment manufacturers.

Once agriculture and commodities found themselves in the crosshairs, the equipment needed by those sectors took a hit.

At its lowest, the First Trust Global Engineering and Construction ETF (NYSE: FLM) fell more than 13% from its peak in January to its low at the end of March.

For other companies, the pain was even worse…

Shares of Caterpillar (NYSE: CAT) have declined almost 15% over the past three months. Investors were warned that China accounted for 5% of its machinery sales.

That made Caterpillar a dangerous equity to hold. The anxiety was building up in shares.

And when the world’s largest heavy equipment manufacturer reported first quarter earnings, the resulting ripples were felt throughout the entire market.

Caterpillar shares dropped more than 6% on the report. And the Dow plummeted 600 points.

Now, on a fundamental level, Caterpillar’s first quarter revenue rose 31% to $12.9 billion, beating expectations. But Chief Financial Officer Brad Halverson said the first quarter probably represented “the high-water mark” for 2018.

You could hear tires screeching to a halt! Elation mutated to panic.

But with the tough talk darkening the doors of equipment manufacturers, Halverson’s high-water mark comment was only the latest anxiety-producing moment.

In fact, shares of Deere & Company (NYSE: DE) are down more than 18% over the past three months.

Shares of truck maker Navistar International Corp. (NYSE: NAV) have tumbled more than 21% over the same span and almost 30% so far this year.

Even shares of Japan’s Komatsu Ltd. (OTC: KMTUY) – the second-largest heavy equipment maker in the world – are down 7% over the last few months. Komatsu is even more reliant on China for sales.

In fact, in Komatsu’s fiscal year 2017, its sales of hydraulic excavators in China increased more than 100% in eight out of 11 months.

Komatsu’s total retail base sales in China have grown more than 100% in seven out of 10 months.

It’s the heavy equipment manufacturer’s strongest growth market. Considering the overall size of China’s economy, it’s an extremely important one as well.

China is what helped Komatsu’s revenue increase more than 50% in the third quarter, as well as more than 47% through the first nine months of fiscal year 2017.

China currently accounts for 6.9% of Komatsu’s total sales. Though, as I mentioned, obviously this is an important strategic market.

Just like with many other heavy equipment manufacturers, North America is the most important market for Komatsu. It represents 24.2% of total revenue. And in terms of mining and construction equipment, the percentage is almost double that.

China is important. No doubt about it. And it will garner headlines as tariff talks continue.

But the global economy is heating up this year. The heavy equipment industry is expected to still see double-digit growth.

Caterpillar is projected to see revenue increase 12.5% in 2018 to $51.13 billion. And maybe the first quarter was its high-water mark for the year.

Navistar is also expected to see revenue grow nearly 12.5% this year to $9.63 billion. And shares have surged recently on takeover rumors by Germany’s Volkswagen (OTC: VLKAY).

But Deere & Company is far and away on the fastest upswing. Revenue growth will more than double Caterpillar’s, increasing 29% to $33.48 billion. In the second quarter, Deere’s management believes revenue will increase between 30% and 40%.

We’re conditioned to tune in to the “will they or won’t they” story. It’s defined television for generations. And now it’s helping define geopolitics and trade.

For investors with a strong stomach – and a stronger conviction that they won’t – heavy equipment manufacturers look like a bargain here. With double-digit growth on the horizon, the sector looks like an opportunity regardless of whether they do or don’t.

Good investing,

Matthew