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Caterpillar, Joy Global, Deere: Is Now a Good Time to Buy?


Shares of large-cap global manufacturing companies remain attractive and poised to deliver more gains. Here's why.

The big, heavy manufacturing equipment companies such as Caterpillar (CAT), Joy Global (JOYG), Deere (DE), and Cummins (CMI) had been market leaders through most of 2010, benefiting from global growth and record profit margins. But the group slipped notably during the initial June swoon, as measured by the Spyder Select Industrials (XLI) which has come off some 10% since the beginning of May highs. Some of the individual names mentioned above such as CMI have slipped as much as 20% in a six-week time period. But with the market's recent rebound and Friday's positive ISM number, it appears these mighty manufacturers are back on track. The question, as always, remains: Is now a good time to buy?

The words and actions from companies such as General Motors (GM), which is planning on a $2 billion capital expenditure and has plans for hiring 2,000 workers, and Caterpillar, which provided a very optimistic outlook last week and recently chose Texas to build a new plant, are part of a new manufacturing boom in the United States. But will this bull market for these behemoths be able to survive, or will it turn into a bust?

No Labor Pains Lead to Gains

The past few years have seen an unprecedented shift in the balance of prosperity. Corporate profits have soared while labor has seen scant gains. This is due to a confluence of events -- most notably the recession, in which unemployment and the ability for workers to win wage or benefit increases, has been nearly impossible; add to this corporations' ability to leverage technology to increase productivity and profit margins, especially in manufacturing sector, which has soared to record levels. Capital expenditures by businesses on equipment and software have been a bright spot during this recovery. Capex spending as a component of GDP has consistently been a solid contributor to total GDP growth since the fourth quarter of 2009. The current capex level is above the reading just prior to the recession (fourth quarter 2007), and total GDP has also surpassed its fourth-quarter 2007 levels in real terms. Meanwhile, corporate profits have not only topped levels just prior to the recession but are now at record highs, and a similar trend exists for profits as a percentage of GDP.

But one of the problems causing longer-term concerns is that all that spending has been buying machines and software instead of hiring people. Since the recession ended in June 2009, businesses' investments in equipment and software surged by a total of 26% (in real terms, not annualized) to the first quarter of 2011, and real GDP grew by 4.9% during that period, However, according to data from the Bureau of Economic Analysis at Commerce, the index of aggregate hours worked for private employers expanded by only 2.3%, and the total number of employed persons on private employers' payrolls grew by just 0.6%.

If employers added new employees at the same rate GDP grew during this period, there would be 4.3 million more people working now than there actually are, and the unemployment rate would be roughly 6.3% instead of 9.1%. And to be sure the much of the spending on software is coming from old like manufacturers. In fact, this seems to be crux of their transformation; the fact is that many of these "assembly line" businesses actually face a labor shortage as there is a dearth of qualified candidates to run the increasingly technological and automotive manufacturing process. As a CEO said the other day, "When we have openings for warehouse positions we get a line of a hundred people, but when looking for a tech person to manage the process we have to comb and cajole a few hundred to find someone." I don't see how labor costs for companies like Caterpillar, which was early in slicing head count and restructuring pay and pension, will see upward pressure any time soon.
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No positions in stocks mentioned.

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