What if there is no huge pent-up demand from shoppers?
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I’m getting vaccinated this Monday—which means it’s nearly time to indulge all that pent-up demand that Wall Street says I have. What is it that I’m supposed to want again?
Where I live, vaccines were suddenly made available this past week to all people over 30. I just made the cutoff by 18 years.
Now to unchain my ravenous consumer animal spirit: Release the Kraken! The problem is, the Kraken’s pretty comfortable. He just spent a year sprucing up his surroundings. I tried releasing him, but all he did was book a family trip for summertime and make loose plans to meet friends for drinks when this craziness passes—hardly Kraken-like rampaging. Then he went back to reading about how to care properly for a pizza stone.
“Consumption has remained very strong despite the pandemic,” Savita Subramanian, head of U.S. equities at BofA research, told me this past week. “When we look at our own Bank of America credit card data, what’s really surprising is that consumers didn’t stop spending on durable goods in 2020, especially at the higher end of the income spectrum. So our sense is that the pent-up demand really isn’t in the consumer space, especially consumer goods.”
Uh-oh. Part of the reason the S&P 500 index leapt past 4000 this week, to a level 19% above its prepandemic peak, is that consumer spending is supposed to come screaming back. What if it only comes whistling back, cheerfully but unhurriedly, while jingling its keys? What if the recovery is already priced in? What if peak good news for stocks hits when that needle goes into my shoulder? Also, if shoulders were always an option for vaccines, why did doctors spend so many years injecting them into rear ends?
Answers to most of those questions could decide whether the S&P 500 ends higher or lower this year than now. Subramanian is guessing lower—3800, down around 5% from recent levels—even though she thinks economic growth and earnings gains will impress this year.
Bonds could provide fresh competition for stocks now that the 10-year Treasury yield has overtaken the S&P 500 dividend yield.
Better to select stocks that give exposure to real pent-up demand—for capital expenditures by companies rather than purchases by consumers, Subramanian says. Sure, theme parks and bars are likely to be mobbed this summer. But there is not much evidence for a coming boom in shopping for goods. And the consumer discretionary sector trades at a larger-than-usual premium to the industrials and materials ones, where many beneficiaries of capital spending reside.
Conditions are ideal for a pickup in capex even before factoring in a White House push to spend mightily on infrastructure and green technology. The average age of private nonresidential fixed assets is the highest in 55 years. Factory utilization is reaching levels that have coincided with past capex sprees. And CEOs say in surveys that they plan to increase capital spending in coming quarters.
To identify capex beneficiaries, analysts at BofA compared decades of company sales with aggregate changes in nonresidential spending on structures, tech equipment, and factory equipment.
The resulting ranking isn’t a buy sheet. Investors should consider it in the context of other factors, like valuation, and how far shares have already rebounded on recovery news.
For example, amid a semiconductor shortage, Intel (ticker: INTC) announced late last month that it would spend $20 billion on two new U.S. chip factories. That has given a quick boost to three chip-equipment companies that rank well on BofA’s capex screen. Applied Materials (AMAT) is up 22% since the Intel news, and both Lam Research (LRCX) and KLA (KLAC) are up 17%.
Near the end of 2019, I wrote in Barron’s that Applied, up big over the prior year, was still worth buying even though it no longer appeared especially cheap at $61 a share. Now, it’s over $140, or about 22 times projected earnings for the company’s next fiscal year, ending October 2022. Still, that is close to a market multiple, with favorable exposure.
Other companies whose sales have tended to rise with capex include, not surprisingly, Caterpillar (CAT), at 22 times next year’s earnings, and Thermo Fisher Scientific (TMO), which makes equipment for factories and labs, at 23 times.
WestRock (WRK) makes packaging, like the corrugated shipping boxes that show up on doorsteps, but also packaging systems bought by factory owners. It trades at 12 times estimated earnings for its fiscal year ending September 2022.
Parker-Hannifin (PH) makes pumps, sensors, valves, and other industrial doodads, and trades at 20 times expected earnings for its fiscal year ending June 2022. Martin Marietta Materials (MLM) sells crushed rock, cement, and other materials that may seem a strange fit for a stock trading at 26 times next year’s earnings, but the company is expected to grow earnings at double-digit percentages for years to come. Cummins (CMI) makes engines for trucking, transit, construction, and other applications, and trades at 16 times next year’s earnings.
A number of energy companies turned up on the list, including driller Schlumberger (SLB), whose earnings have only begun to rebound from depressed levels, at 20 times next year’s earnings, and refiner HollyFrontier (HFC) at 13 times.
Whichever stocks investors select, Subramanian says it’s time to shift from deep-value or “dash-to-trash” stocks, which tend to jump at the start of a recovery as their financial peril recedes, to midcycle value stocks, which she says are characterized by strong and durable cash flows.
Meanwhile, I’ll keep watch between my first shot and my second for signs that I have more pent-up demand than I realize for consumer goods.
Off the top of my head, if things go according to plan with this pizza stone, I could soon be in the market for a cutting wheel.
Write to Jack Hough at [email protected]. Follow him on Twitter and subscribe to his Barron’s Streetwise podcast.
