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Equities: Weighing In on IndustrialsVideo

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Description: Are you underestimating the returns potential of industrials? Christopher Baggini, Global Head of Equity Strategy, explains why this sector is poised positively across global markets.

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Transcript: <p><b>JPM – Equities October – Transcript – TIME: 6:57&nbsp;</b></p> <p>[upbeat music]&nbsp;</p> <p>[bell dinging]&nbsp;</p> <p>[applause and cheering]&nbsp;</p> <p><b>Mr. Goldberg:</b> Hi and welcome to Markets Monthly. I’m your host Andy Goldberg, and today I’m joined by Chris Baggini. Chris is our new Head of Global Equities here at J.P.Morgan. Chris, welcome, we’re really excited to have you.&nbsp;</p> <p><b>Mr. Baggini: </b>Thanks Andy, glad to be here.&nbsp;</p> <p><b>Mr. Goldberg:</b> So Chris, in the past, we’ve had members of your team come on to talk about various aspects of why they’re constructive or positive on equity markets.&nbsp;</p> <p><b>Mr. Baggini:</b> Right.&nbsp;</p> <p><b>Mr. Goldberg:</b> I wanted to have you in today to talk a little bit about a recent upgrade, and that upgrade has been to the industrial sector. Maybe you can start by telling us what some of the key underpinning pillars of that call have been.&nbsp;</p> <p><b>Mr. Baggini:</b> Yeah, we’re very positive on the industrial sector right now. And it’s really supported by a coordinated growth cycle story. So we’re seeing accelerated growth in the U.S., Eurozone, Japan and China. All very positive as far as the purchasing managers index. We’re looking at a lot of broad data, including the PMI data. Capacity utilization has been very strong. We’re also seeing business optimism continue to be robust in the United States. So with that macro backdrop, we realized that earnings really do drive stock prices at the end of the day. And when we exited Q2, we had a very strong earnings story to tell for industrials. During Q2, we had the average company beat by 6.5%. 87% of those companies in this sector beat expectations.&nbsp;</p> <p><b>Mr. Goldberg:</b> That broad?&nbsp;</p> <p><b>Mr. Baggini:</b> It was that broad. This sector ended the quarter with very strong backlogs and very high incremental margins. So we think there’s more to go on the earnings story.&nbsp;</p> <p><b>Mr. Goldberg:</b> I know your team has been following this sector and tracking it for a while. Can you talk to me a little bit about the timing of the call, you know, why now?&nbsp;</p> <p><b>Mr. Baggini:</b> Right. A couple of broad themes. Number one, industrials are notoriously late cycle. By that they outperformed in 1999, they outperformed in ‘06 and ‘07. Late cycle, you think about a capacity utilization is higher, that’s when the spending occurs. Additionally, the timing is perfect because during the summer the group actually underperformed. It pulled back to a discount to the market, where it usually trades at a premium.&nbsp;</p> <p><b>Mr. Goldberg:</b> Just ease my mind a little bit or not depending on your view-on your view, but when you say late cycle and 1999 does that mean end of cycle?&nbsp;</p> <p><b>Mr. Baggini:</b> Yeah. No, I think, you know use an analogy for a baseball game, a lot of people wonder what inning we’re in. And I tell people we’re probably in the fifth or sixth inning. But there’s no saying the game has to be nine innings. We actually could see a longer game this time.&nbsp;</p> <p><b>Mr. Goldberg:</b> Great. There’s still not a lot of inflation-&nbsp;</p> <p><b>Mr. Baggini:</b> [Interposing] Correct.&nbsp;</p> <p><b>Mr. Goldberg:</b> -the Fed’s not overly active. So let me shift gears and ask you this question: When we talk about the industrial sector, lots of different kinds of companies, is it a blanket statement that you like industrials or are there areas or pockets that you like more than others?&nbsp;</p> <p><b>Mr. Baggini:</b> Yeah, we definitely prefer three sectors in particular.&nbsp;</p> <p><b>Mr. Goldberg:</b> Okay.&nbsp;</p> <p><b>Mr. Baggini:</b> They do have one common theme, and that’s consolidation. Consolidation has been very strong across this industry for several years. In the case of aerospace and defense, one of the sectors we like, we’ve seen not only consolidation, but we’ve seen increased budgets. The change from the Democrats to Republicans has really strengthened the budget battle that we have here in D.C. and it’s a big upside to potential growth rates. Over the last, call it six to eight years, these firms have been able to sell their products more overseas, so international defense sales have actually been very strong and are an important part of this story.&nbsp;</p> <p><b>Mr. Goldberg:</b> Okay.&nbsp;</p> <p><b>Mr. Baggini:</b> The second sector we like is machinery. So while I mentioned PMIs and business optimism, this is the sub-sector that’s most closely aligned with an improvement in cyclical growth.&nbsp;</p> <p><b>Mr. Goldberg:</b> Okay.&nbsp;</p> <p><b>Mr. Baggini:</b> In that space, within machinery, we’ve seen consolidation as well. Incremental margins are very high and improving. So this is a case where we see more positive revisions occurring with the strong economic cycle we have.&nbsp;</p> <p><b>Mr. Goldberg:</b> Great.&nbsp;</p> <p><b>Mr. Baggini:</b> In the case of transports, we do like rails, and we like airlines as well. In particular, airlines have pulled back during the summer months and traded at significant PD discount to the marketplace. There again, we’ve seen consolidation. The top four companies, the majors, used to have 60% market share, now the top four have 80% market share. It’s helped industry margins, now basically equivalent to the S&amp;P 500.&nbsp;</p> <p><b>Mr. Goldberg:</b> You mentioned margins and airlines in the same paragraph.&nbsp;</p> <p><b>Mr. Baggini: </b>Right.&nbsp;</p> <p><b>Mr. Goldberg:</b> I’m thinking fuel prices. How important is the fuel price call to the outlook there?&nbsp;</p> <p><b>Mr. Baggini:</b> It’s still the most important variable cost that they have, but their balance sheets are so strong now, that they are actually able to go out in the futures market and lock in prices.&nbsp;</p> <p><b>Mr. Goldberg:</b> Let me ask you one final question. This story makes a lot of sense to me overall. You’ve got this global reflation story. Those sectors or sub-industry groups that are most levered to the cyclicality there make a lot of sense. But you also mentioned when you said aerospace and defense the new administration.&nbsp;</p> <p><b>Mr. Baggini:</b> Right.&nbsp;</p> <p><b>Mr. Goldberg:</b> Now to my mind, the real change hasn’t really happened yet. So is your call dependent on more legislation happening, or would that just be, you know, like a nice cherry on top?&nbsp;</p> <p><b>Mr. Baggini:</b> Yeah, it’s independent. It’s a call option on what happened in D.C.&nbsp;</p> <p><b>Mr. Goldberg:</b> Sure, okay.&nbsp;</p> <p><b>Mr. Baggini:</b> The D.C. success is not part of our base case here.&nbsp;</p> <p><b>Mr. Goldberg:</b> Got it.&nbsp;</p> <p><b>Mr. Baggini:</b> It would be a positive if tax rates came down, specifically the three sub-sectors I mentioned. All have very high tax rates relative to the market. If we had an infrastructure bill, it would be wildly positive for those groups. So it is a call option, but it’s not part of our base case.&nbsp;</p> <p><b>Mr. Goldberg:</b> Nice to have, don’t need it.&nbsp;</p> <p><b>Mr. Baggini:</b> Exactly.&nbsp;</p> <p><b>Mr. Goldberg:</b> Okay. Chris, great. Any final thoughts before I wrap it up?&nbsp;</p> <p><b>Mr. Baggini: </b>Yeah, we’re still very positive on the equity markets. We think it’s the place to be. We’ve been positive on technology, healthcare and financials for most of this year and industrials are- is the fourth leg.&nbsp;</p> <p><b>Mr. Goldberg:</b> I think it’s a story that makes a lot of sense. We’re going to kind of keep track of it.&nbsp;</p> <p><b>Mr. Baggini:</b> Okay.&nbsp;</p> <p><b>Mr. Goldberg:</b> I’d love to have you back if you’re open to it.&nbsp;</p> <p><b>Mr. Baggini:</b> Love to.&nbsp;</p> <p><b>Mr. Goldberg:</b> Great. Thanks for being here and congrats.&nbsp;</p> <p><b>Mr. Baggini:</b> Thanks, Andy.&nbsp;</p> <p><b>Mr. Goldberg:</b> And for those of you watching, we always appreciate your time. Please join us again. Thank you.&nbsp;</p> <p>[END]<br> </p>

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