Rising Steel Prices: Another Reason to Question the Capital Good Trade

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SEE LAST PAGE OF THIS REPORT Graham Copley / Nick Lipinski

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gcopley@/nlipinski@ssrllc.com

February 21st, 2017

Rising Steel Prices – Another Reason to Question the Capital Good Trade

  • We have now written a couple of pieces focused on what looks like an investment opportunity in Conglomerates, (with GE highlighted), and a worry in general about Capital Goods.
    • The first piece (last week) looked at the recent rally in Capital Goods relative to Conglomerates and focused on a very regular repeating pattern that if continued would suggest that Conglomerates as a group should outperform Capital Goods meaningfully over the next 6 months.
    • The second piece (this morning) focuses on how much sectors and stocks have run recently in anticipation of improving earnings and whether these rallies make sense.
      • Capital Goods has not run as far ahead as, for example, Transports but expectations (based only on stock prices) have moved sharply relative to earnings.
      • By contrast, GE has seen earnings and returns improve and the stock reflects none of the improving trend.
  • In this short piece we wanted to throw up another red flag for Capital Goods – rising materials costs. Steel, Aluminum and most other metals are increasing in price and China seems quite focused on cutting back output to help with both pollution and oversupply.
    • There are not many periods of time where metals pricing has moved absent some other exogenous shock – but we would direct attention to the period from the end of 2003 to the middle of 2004 – Exhibits 1 and 2.
    • The later peak in steel prices came in the midst of broader market turmoil and it is very hard to tell what factor was driving what element of performance in that period.
  • We are additionally concerned with the more simple idea that – the less opportunity China has to exports steel and aluminum, the more the country will focus on exporting things made of steel and aluminum.
    • While we may not see these products in the US – machinery is the largest single category for US exports and US producers could lose export demand.
  • A chart showing moves in metals pricing is included as Exhibit 3.
  • We remain very interested in the potential value opportunity at GE, especially relative to some of the more expensive Capital Goods names which are now discounting some quite challenging forward earnings: PH, DOV, DCI, ITW, GGG, LECO and CAT.

Exhibit 1

Source: Bloomberg, Capital IQ and SSR Analysis

Exhibit 2

Source: Bloomberg, Capital IQ and SSR Analysis

Exhibit 3

Source: Bloomberg, Capital IQ and SSR Analysis

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