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In my previous missives about 2020, I outlined our market view from 30,000 feet, so to speak, that our base case outlook is U.S. stocks rise 10% plus—to about 3450 on the Standard & Poor’s 500 index. This is predicated on index earnings growth of about the same amount or better this year. Let’s dive...

Overweight Value, Cyclicals; Favor Tech, Energy, Industrials
  • Signal from Noise
Sep 18, 2019

Market's Kibosh on Oshkosh Is a Potential Opportunity

-A relatively mild CEO warning about 2020 sent the stock reeling over 10% -OSK raised guidance and has a sizeable backlog of $5 billion; a $110-$120 stock? -OSK’s mix of mission critical vehicle businesses bodes well for long term growth What’s the power of a few words? The recent sharp drop in the stock price of Oshkosh (ticker: OSK) shows pretty convincingly that Mr. Market (too) often shoots first and asks questions later.  In the case of Oshkosh, on August 1, the company gave out a cautious comment on 2020 about one of its main businesses, which knocked the stock. Admittedly, it was a bad day for the market, too.  However,  a deeper look into the OSK selloff suggests Mr. Market’s kneejerk emotional reaction has provided a relatively inexpensive long term entry point for the stock of an extraordinary industrial company. OK. First, what’s with the name, Oshkosh? Really? I know it sounds like a company that makes infant toys, but the truth is OSK is one of the biggest yet relatively unknown makers of specialized, defense and emergency vehicles and equipment. It’s mission critical stuff, from Department of Defense heavy and medium transports to firefighting trucks and emergency response vehicles and even concrete mixer trucks. The name comes from the town where it’s headquartered in Wisconsin, but OSK is a global firm, selling around the world, with manufacturing plants around the country and in Europe and Asia. So what happened exactly?  In the most recent earnings call, on August 1, the CEO noted the “access equipment markets in North America and Europe could be down modestly” next year.   Access equipment, like telehandlers and aerial work platforms, is roughly 49% of sales, while DoD is 24%, fire emergency 15% and commercial 12%. Meanwhile, it was an excellent quarter, with sales up 10% to $2.4 billion and EPS up to $2.72 from $2.05 in the year ago quarter. Moreover, the company raised guidance for fiscal 2019, which ends this month. But investors chose to focus on the negative here. Now I’m not suggesting one ignore that 2020 concern, but context is everything.  Half of OSK’s sales isn’t really cyclical. The DoD business, which rose 7% in the first nine months of the fiscal year ending Sept. 30, should grow even faster under the Trump Administration. Access equipment and fire & emergency margins have been rising.  And as we have noted before, FSinsight believes we are mid-cycle not late cycle.  That suggests that while OSK is cautious about access equipment, it’s likely things won’t slow to the extent the market believes.  That leaves room for opportunity. The stock has dropped more than 10% to around $76 and far below all-time highs of $96, reached in early 2018. Effectively, the stock’s been orbiting around $70 since then. OSK is a robust business, one that’s stood the test of time for over a century. New Constructs, an independent research firm, points out the long term trends for OSK are positive and the valuation prices in a permanent profit decline.  While the potential decline in 2020 demand is a concern, the market underrates OSK’s diversified businesses; its innovation and excellent leadership, and its long term growth potential.  “These factors should help OSK weather any cyclical downturn and deliver long term value.”  OSK’s diversification also gives it a competitive advantage by allowing it to provide more comprehensive product solutions to customers than many customers. The stock is the cheapest it’s been since 2016, after which it doubled, notes New Constructs in a recent report. Here’s what I like about Oshkosh: it sports a 23% return on equity; double digit dividend growth; a sizeable backlog; and excellent product reputation in mission critical businesses. OSK shares currently trade at a forward price/earnings (P/E) ratio of 9.8 times, significantly lower than its 10-year average and median P/Es of 16 times and 14 times, respectively.   Now Oshkosh, like its name, is a bit of an odd bird.  Given the breadth  of its businesses, there’s no perfect comparable peer that is publicly-traded.  I’ve put together a table of firms that are similar to different extents, makers of cranes and aerial equipment and defense companies. Oshkosh is valued at the lower end, with the crane/machinery firms, and far below the defense firms, which get 14-16 times P/E.  With only 25% of the business in defense, I don’t suggest Oshkosh is a defense company, but just maybe it deserves a better multiple, one closer to defense than cranes and construction.  If we are mid-cycle, then EPS could reach $10 per share in a couple of years. If the market applied a more reasonable 11 to 12 times PE, the stock price could hit $110 to $120. Here’s another anecdotal but interesting bullish fact: Wall Street’s sell side is lukewarm on Oshkosh stock.  It’s hard to go wrong longterm voting against the aggregate view from the sell side.  Of the 18 analysts who follow OSK, 44% have a Buy rating on the stock, the lowest level since the 2008-09 market crash. It’s not hated, but Wall Street sure doesn’t like it much. Where could I be wrong?  If the economy is late cycle and the recession risk elevates, OSK’s stock could drop some more. Bottom Line: For investors with a longterm horizon, OSK looks cheap.

Don't Fight the Fed: Go for Growth and Cyclical Sectors

What’s a Federal Reserve Board interest rate cut worth to the stock market? We’ll soon find out, but history suggest it’s quite valuable to investors when the Fed reduces rates during an expansionary period rather than ahead of or during a recession. As you’ll see below, such a move will boost U.S. cyclical, growth and large cap stocks, among other asset classes. As the second quarter earnings reporting season gets underway, I’ve heard a growing chorus of strategists and investors call for a pullback in equities. Such bearishness is perhaps no surprise given the S&P 500 index is already up ~20% YTD, and given an earnings recession is underway, the third one since 2009. (For more on this see page 1.) Two weeks from now, the U.S. central bank is likely to make its first interest rate cut in almost 5 years and, as I’ve pointed out previously, such a move has dramatic impacts on markets. Moreover, given the paucity of investor conviction, one could argue there is a lot of cash on the sidelines, especially considering the substantial retail outflows from equity mutual funds in 2019 YTD. Equities are likely to see a strong boost from a cut. Since 1971, when the Fed makes its first cut and Leading Economic Indicators (LEIs) are still positive (as is the case currently, hence, we are not in recession), stocks have risen 100% of the time three, six, nine and 12 months later. In other words, don’t fight the Fed. The timing is key. When the Fed cuts and the U.S. economy is in expansion, the move drives positive equity returns. 100% of the time. (See nearby table.) The median nine months gain is ~18%, hence, we expect stocks to rise strongly into YE and believe our current 3,125 target is low. Cyclicals, which are outperforming the market by 280 basis points and defensives groups by 690 bp, is a group that should be positively affected. Multiple factors are behind this but I think the rally in high-yield and easing financial conditions are supportive. Moreover, the steepening of the U.S. Treasury 30 year – 10 year yield curve spread historically is coincident with cyclical outperformance. The rate reduction is also likely to favor growth stocks over value stocks, a continuation of the dominant theme for roughly the last decade. I have written extensively on the thesis that rising interest rates favor asset intensive businesses, such as value stocks, so the cut is likely a headwind for value. Similarly, the Fed’s anticipated move will probably help boost large market capitalization stocks over small. While this may sound counterintuitive, I see large-caps benefitting. Why? This further amplifies the equity “there is no alternative” (TINA) to stocks thesis, and US TINA in particular. I believe investor equity flows will more likely accrue to the big guys over the small fry. Additionally, I am beginning to wonder if a long-term mean reversion is underway. Since 1999, small-caps massively outperformed large-caps, but in the past eight years performance has really flattened. Further back, from 1990-1999, there was massive small-cap underperformance—is this a repeat? I’ve favored U.S. equities over the rest of the world (ROW) for some time now, but I expect the likely impact of a cut is for the S&P 500 to further pull away from the ROW. I base this on three cornerstone arguments: (i) US corporates have strong franchises; (ii) supportive White House/gov’t policy and (iii) accommodative financial conditions in US. A Fed cut is icing on the cake. My assessment since the start of the year is that the U.S. continues its relentless outperformance versus ROW. (See chart below.) Source: FS Insight, Bloomberg, FactSet Finally, I think gold will gain traction as a “hedge” around negative rates, but it will likely also be good for emerging markets. Gold outperformance is supported by Fed cuts (weaker USD, more zero rate bonds). But there is a curious positive relationship between rising gold and rising EM equities. While weaker USD is the likely link, I wonder if this means EM could lift-off on a Fed cut. Bottom line: While consensus may be right on a pullback, Fed cuts matter more. We see a 2H19 rally and recommend the following stocks: The tickers are GOOG, MNST, NKE, TSLA, AAPL, AMGN, AMP, AMZN, AXP, BF/B, BKNG, CSCO, FB, GRMN, NVDA, PM, PYPL, ROK, XLNX, ADP, CLX, MA, PG, V. Figure: Comparative matrix of risk/reward drivers in 2019 Per FS insight Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500 ** Performance is calculated since strategy introduction, 1/10/2019

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