There’s a big change coming in the second half of 2016 and you might not even be aware of it.
Manufacturing and construction, two of the building blocks of the U.S. economy, are on the upswing.
Why should you care? After all, manufacturing is just 10% of the overall U.S. economy now.
But it has such a big psychological impact when it is doing well, that optimism in manufacturing has the ability to really light a fire under the rest of the economy.
Construction, which has been in the doldrums since the housing bust, can have a similar impact. It provides thousands of good paying jobs over long periods.
If both manufacturing and construction are humming at the same time, the U.S. economy becomes virtually unstoppable.
We could be in for a whole new paradigm in the second half of 2016.
The Manufacturing Turnaround
With oil in the midst of its worst price plunge of the last 50 years and China slowing, U.S. manufacturing slowed in 2015 as well.
For 5 months, American manufacturing was in a slump. The ISM for Manufacturing was in contraction, with readings under 50, from October 2015 through February 2016. Many were calling this a “manufacturing recession” complete with job lay offs, especially in the energy sector.
In February, however, crude prices bottomed and reversed course.
I don’t think it’s a coincidence that oil and manufacturing bottomed at the same time.
Take a look at this chart for the ISM for manufacturing since 2013.
It’s not surprising that it started to weaken in 2014, just as crude prices did, and then slumped right into the worst of the crude sell off.
For 4 straight months, manufacturing has picked up steam with June 2016’s reading of 53.2 the highest since February of last year. New orders, at 57, were the highest since March.
All indicators are pointing to manufacturing gaining strength.
Is it out of the woods? Is the manufacturing recession over?
Some indicators in the index continue to remain weak, such as employment. While employment is rising, the numbers indicate that companies are being cautious in adding new members to the team.
This would be normal, however, given the length, and severity, of the downturn. It’s going to take more than a few turnaround months for the companies to believe that the strength is here to stay.
Construction Continues to Pick-Up
The construction industry is made up of three segments: residential, non-residential and public.
This is an important distinction to remember because most people pay attention only to residential activity but non-residential and public construction are also big drivers of the economy.
Since the 2008 housing bust, new construction in the housing market has been well below the average seen in the last decade. Of course, that was distorted by the bubble.
Single family and multifamily construction, however, has been on the upswing. They are moving in the right direction.
Multifamily, in particular, has been extremely hot in the last few years although most of that has been concentrated in 12 major metropolitan areas in the form of luxury apartment buildings.
Since 2010, construction starts, for all three segments, have shown annual year over year gains including a 10% gain in 2015.
Big Projects are Heating Up
In May, the $3.8 billion Dakota Access Pipeline was started. It will stretch across several states including North Dakota, South Dakota, Iowa and Illinois. It will connect the Baaken to existing pipelines in Illinois.
This is a big project in an area that has seen lots of layoffs due to the crude plunge.
Highway and bridge construction also increased in May thanks to the passage in late 2015 of the new transportation bill.
In June, according to the Dodge Momentum Index, which tracks construction starts across the country, 14 new projects worth $100 million or more entered the planning stages in the month, nearly double that of May.
Since these are just planning, or starting, that would indicate the construction spending will rise later in the year and into 2017 as these projects get underway.
Low Rates Means More Construction
The construction environment remains favorable for the remainder of this year.
Long term interest rates remain low which means its cheap for builders to borrow and the banks are wide open to lending right now. One area of caution, however, is in multifamily construction where some banks are tightening lending in over saturated markets like Houston.
States are also able to finance construction through bond measures which means more construction in the months to come.
The Federal government may be likely to spend even more money on infrastructure, depending on the tone and direction of the election. Donald Trump has pushed transportation infrastructure spending in his agenda, in the form of new airports and roads.
Non-residential construction is now just below the 2009 peak and it still has upward momentum.
Residential construction is also moving in the right direction. I don’t expect it to approach the bubble highs, if ever, for quite some time as that demand was artificially inflated. But the millennials are a big generation and they will need housing, especially in the urban areas.
The Building Blocks
Manufacturing and construction are two of the building blocks that the U.S. economy needs to pick up steam.
They are also being ignored by investors. Now is the time to start snooping around in these sectors. I’m expecting the earnings estimates to continue to rise over the next few months which means better Zacks Ranks.
1. How to Play Manufacturing
“Manufacturing” can mean a lot of different things from the pure play big industrial manufacturers with global reach to the company that is making washers to ship to the Home Depot.
I like to play this area by buying the chemical companies. It’s the chemical companies that make the products that go into many of the manufacturers end-products. You start with the chemistry first.
The chemical companies are also a large, diverse group so it can be overwhelming, but I started by looking for the best, high ranked Zacks stocks.
1. Koppers Holdings (KOP)
I discovered Koppers when the corporate insiders bought a bunch of shares two months ago. The shares were already trading near a new high when the insiders jumped in which means they had to have a lot of confidence that things were turning around at the company to buy in.
Koppers is a small cap company that makes carbon compounds and commercial wood treatment products, especially for the railroad industry.
It is really focused on its Performance chemicals segment, especially that used in railroad maintenance and on home roofs. An improving housing market actually benefits Koppers as well.
Koppers is a Zacks Rank #1 (Strong Buy). Shares are trading at 16x despite the shares being at new record highs. This is still an attractive valuation especially given its expected earnings growth.
2016 earnings are forecast to rise 27.7% and another 29.7% in 2017. Not too shabby.
2. Trinseo S.A. (TSE)
Trinseo is a mid-cap company specializing in emulsion polymers and plastics. It used to be part of Dow before being spun-off.
Its key end markets are rubber, latex and plastics and it also has a big styrene business.
Shares were on a wild ride after the Brexit on fears that the European business would be hit, but UK revenue, as a total of the entire business, is under 5%. So it’s a little too early to have a full scale panic.
The stock is dirt cheap. It trades with a forward P/E of just 6.9.
It’s also one of those chemical companies that has been around forever so it rewards shareholders. Trinseo pays a dividend currently yielding a healthy 2.7%.
Trinseo is a Zacks Rank #2 (Buy). Earnings are expected to rise 42.4% this year, with a big chunk of that based on strong styrene margins.
2. How to Play Construction
In making a plan to get into the construction industry, your first instinct may be to buy the home builder stocks or builder ETFs.
Yes, that would give you exposure to the residential side of the construction industry.
But I don’t believe that’s where the big gains are going to be made.
There are plenty of big infrastructure projects going on, such as the Dakota Access Pipeline I discussed above, which specialty construction firms will be a part of. Look to the general contractors for opportunities.
There are several top picks in this space. These companies cover different aspects of the construction industry.
For instance, Zacks Rank #1 (Strong Buy) Dycom Industries (DY) is a big player in wireless infrastructure.
MasTec Inc. (MTZ), also a Zacks Rank #1 (Strong Buy) is big in communications and pipelines. It will be involved in the building of the $3.8 billion Dakota Access Pipeline.
Neither of these stocks are cheap, even though fundamentals are strong. Dycom is trading at 21x while MasTec has a forward P/E of 18.
My best pick in this area, however, has both double digit growth as the others do, but also has really cheap fundamentals.
3. Tutor Perini (TPC)
Tutor Perini is a $1.2 billion market cap general contracting firm that works on subways, tunnels, sports stadium and other big infrastructure projects.
As of Mar 31, 2016 it has a near record backlog of $8.2 billion, up 9% year over year. That’s the largest backlog since the third quarter of 2008.
It continues to get new projects. It recently won a $100 million contract for the expansion of the Maryland Live! Casino.
After a lackluster 2015, the company has really turned it around on the growth front. Earnings for 2016 are expected to jump 76.2% and another 16.5% in 2017.
Shares are cheap even though they’ve been hitting new 52-week highs. Tutor Perini trades with a forward P/E of 11.6. It doesn’t pay a dividend.
Tutor Perini is a Zacks Rank #3 (Hold).
Think Expansion, Not Contraction
What if the economy is actually starting to gain steam, instead of losing it?
Construction and manufacturing is where you want to be coming out of a slowdown. They are the first to reap the benefits of a growing economy.
With record low interest rates and a solid job market, I’m bullish on America in the second half of 2016.
The strong double digit growth rates for all of these companies show that the analysts are bullish too. Keep an open mind on value opportunities. They are always out there somewhere, even when the stock indexes are hitting record highs.
Happy Investing.
