April 14, 2011 – By Scott Malone
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BOSTON (Reuters) - U.S. manufacturers will have their work cut out for them if they want to impress Wall Street over the next few weeks.
Profit growth has been strong across the industrial sector for much of the past year, and analysts believe that momentum continued in the first quarter, with double-digit percentage earnings growth forecast for companies including General Electric Co <GE.N>, Caterpillar Inc <CAT.N> and Textron Inc <TXT.N>.
The sector's market value has risen with that growth, and industrial stocks, as measured by the Standard & Poor's capital goods industry index <.GSPIC> are up 15 percent over the past 12 months -- outpacing the 10 percent gain of the broader S&P 500 <.SPX>.
They may be paused for a fall if results do not keep up with investors' raised expectations.
"It's easy to satisfy distraction and depression, but now things are better, companies have been reporting rising earnings and it's harder to impress people," said Peter Klein, senior portfolio manager at Fifth Third Asset Management in Cleveland, Ohio.
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"If management starts to show good but not great progress in some of these things, do the stocks start to come back in?" Klein asked.
That's what happened earlier in the week when Alcoa Inc <AA.N> reported profit that topped analysts' expectations but saw its shares fall 6 percent -- their most since August -- after some investors were unimpressed by its revenue growth.
BUMPS IN THE ROAD
Manufacturers face no shortage of worries in the coming months. The price of raw materials including copper are rising, as are energy bills -- U.S. light crude oil futures in February crossed the $100 mark for the first time since the financial crisis in late 2008.
But high energy prices are not entirely bad news for manufacturers. They drive up costs but also stimulate demand for equipment like GE's oil-production gear and Caterpillar's mining vehicles.
"Anything related to energy will have remained strong," said Brian Langenberg, an independent analyst at Langenberg & Co who follows the sector. "The capital spending cycle is definitely for real."
The after-effects of Japan's devastating March 11 earthquake, tsunami and subsequent nuclear crisis are still playing out across the global manufacturing industry. Japanese companies make a wide variety of specialized electronic components that are in short-supply since the quake and investors will be listening for any signs of how that crisis is affected U.S.-based manufacturers.
Earnings reports could also show that the pace of the manufacturing recovery is starting to slow -- after rebounding sharply in 2010 from their recessionary lows, major industrials will have a harder time keeping up their pace of profit growth.
A Manufacturers Alliance/MAPI survey released on Thursday showed manufacturers taking a modestly more cautious view of the economy -- the index fell to 72 from 75 in December, though still well above the 50 mark that separates growth from contraction.
Part of the reason for that decline was that inventory levels were rising. That is a concern since part of last year's growth surge was attributed to customers needing to rebuild the inventories they had cut to the bone during the recession.
"The fact that the inventory index has reached the level it has may be an indication that there is a slowing of the rate of expansion," said Donald Norman, an economist with the Arlington, Virginia-based trade group. "That's something we're going to be watching in the next few quarters."
(Reporting by Scott Malone, additional reporting by Nick Zieminski in New York, editing by Dave Zimmerman)