Photograph by James MacDonald/Bloomberg
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For a sector that makes up only about a tenth of the U.S. economy, manufacturing gets a lot of investor attention.
That’s been especially true lately, given the trade war with China, new tariffs on Brazil and Argentina, plus a proposal by the Trump administration to levy tariffs on certain French imports. And that’s not to mention the problems at
Boeing
(ticker: BA) around its 737 MAX jet, which promises to have an impact on its supply chain for the foreseeable future.
It’s no surprise, then, that factories have been flailing in an increasingly pronounced way since President Trump ratcheted up the trade war in August, and it makes sense that markets have become more reactive to the Institute for Supply Management’s manufacturing report in recent months. The latest update came on Friday, when the ISM said manufacturing conditions haven’t been so grim since June 2009. “It’s a natural reflection of percolating trade war fears,” says Jon Hill, a vice president at BMO Capital Markets. Investors attempting to gauge, and price, economic impact should be focusing on manufacturing data, Hill says.
With that in mind, Barron’s looked back over the past two years to see which industrial stocks have been most highly correlated, either positively or negatively, with the monthly ISM indicator. Correlation assesses the relationship between two variables, though it doesn’t necessarily imply causation.
On the positive-correlation side,
FedEx
(FDX) and
Textron
(TXT) top the list. That makes sense, given the global reach of the freight company and industrial conglomerate and their exposure to international manufacturing. A quick interpretation: A falling ISM means investors can expect shares of those companies to similarly decline, and a rising ISM means investors can anticipate the shares to rise.
But what’s more interesting are companies with negative correlations to the ISM. Among the strongest, with correlations of negative 0.92 and negative 0.91, respectively, are garbage-disposal companies
Republic Services
(RSG) and
Waste Management
(WM).
These companies’ stocks tend to move oppositelythe ISM—a particularly interesting investment thesis when the indicator, and thus manufacturing activity, is floundering. What’s more, the pair of garbage companies exhibit relatively low standard deviations on ISM-release days, suggesting that absent other considerations they are less volatile and thus less risky than other types of industrial stocks with higher standard deviations.
Hamzah Mazari, managing director at Jefferies, says that these garbage stocks are often overlooked and that there is more to them than simply being possible plays during a manufacturing malaise. The business isn’t glamorous, and the companies are underfollowed by Wall Street relative to their market capitalization. But they tell investors a lot about the broader U.S. economy and stock market, Mazari says, in part because they derive nearly all of their domestic revenue by disposing of residential and commercial waste and they explicitly link pricing to inflation.
Moreover, Republic Services and Waste Management tend to lag bigger market downturns by about a year, Mazari says, making them more attractive for investors who think this bull market is late-cycle and expect the S&P 500 to peak sooner rather than later.
Of the two, Mazari prefers Republic Services. One reason: His team mapped monthly building-permit data from the Census Bureau against landfill locations. Republic Services is better positioned, he says, given the number of landfills it operates within a 50-mile radius of construction projects.
Given that there is no end in sight of the China trade war—details of the so-called phase-one deal remain unclear—on Boeing’s troubles, or on rising geopolitical tensions, investors shouldn’t expect a sustained manufacturing recovery soon. The garbage companies’ strong negative correlations to the ISM and their relatively low standard deviations makes them worthy portfolio additions. One person’s junk, after all, can be an investor’s treasure.
Write to Lisa Beilfuss at [email protected]
