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materials costs, which could impede industrials’ prot margins, adversely affecting stock prices.

As a result, managers agree that as the economic cycle matures, stock picking will become even more of a factor in driving potential returns.

Mr. Giroux and Mr. Rottinghaus both say this means that investing decisions are more complex than just determining industrial stocks’ position in the economic cycle.

With the recovery in its middle innings, Mr. Rottinghaus sees advan- tages to tilting toward companies that tend to benet as the economy moves into the expansion phase.

He cites some examples of such late-cycle industrials: Honeywell; United Technologies; Boeing; and Cooper Industries, which manufactures electrical products for commercial construction, a sector that has not yet recovered.

At the same time, Mr. Rottinghaus holds a wide range of industrials that tend to perform well during more than one stage of the economic cycle. He cites, for example, 3M, a diversi-

  • ed technology conglomerate that has

more than doubled off its 2009 lows.

One potential driver of additional gains for early cycle industrials, Mr. Giroux says, could be if they

deploy their considerable cash toward acquisitions and mergers.

An example: industrials giant Danaher. While the rm is expected to grow sales at a reasonable pace over the long term, it could benet strongly from its recent acquisition of medical test-maker Beckman Coulter. “Danaher is more of an early cycle company but creates more value through mergers and acquisitions,” Mr. Giroux says.

Manufacturing Abroad

A striking feature of the current manufacturing rebound is that, while capital spending on equipment and property has increased sig- nicantly, the labor market remains weak—contrary to most recoveries.

But portfolio managers say the lag in jobs is not reective of the health of many larger U.S. companies that have transitioned to very lean, auto- mated domestic production or have moved their manufacturing overseas.

Mr. Rottinghaus notes that, among industrials in the U.S. Large-Cap Core Fund, “almost to a company the growth in manufacturing sales and jobs is not in the United States but overseas because they need to be closer to their customers and because of the expenses of U.S. workers.”

Industrial Production Index January 2000 Through February 2011


  • Shaded bars reflect recessions.









’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 2/11

The industrial production index is seasonally adjusted and indexed to 100 at the average of every month in 2007.

Sources: Federal Reserve Board and Strategas Research Partners.

For example, he says, United Technologies’ Otis elevator division has a booming business in China that is competing with Chinese manufacturers, while producing far fewer elevators in the United States.

Similarly, Joe Fath, a large-cap portfolio manager, cites Emerson Electric, a diversied electrical equipment maker, which has moved some production and research and development to emerging markets. Emerson has about 30% of its sales in these markets, a gure that the company projects will swell to about 50% in just 10 years.

This trend also is evident among some smaller-cap U.S. companies. Mr. McCrickard cites General Cable, which makes communication, indus- trial, and utility products and recently opened new plants in Peru and India, and A.O. Smith, a U.S. producer of water heaters, which is doubling its manufacturing capacity in China and opening a new plant in India.

Partly due to the rise of offshore manufacturing, U.S. manufacturing accounts for just 10% of U.S. gross domestic product, compared with 13.5% in 1995, according to the U.S. Bureau of Economic Analysis.

A Peak in Outsourcing?

At the same time, Curt Organt, a T. Rowe Price industrials stock analyst, says, “the outsourcing trend may have peaked. Many jobs simply can’t be outsourced.”

Mr. Organt says that small U.S. manufacturers that produce bulky or high-end products are more likely to make them in the U.S. or Mexico.

Moreover, the continued weak- ness of the U.S. dollar, steadily rising wages in China, the surge in emerging market energy costs, and concerns over intellectual property favor keeping U.S. manufacturing

Continued on page 10

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