Multi-industry companies like General Electric Company (NYSE:GE) and 3M Co (NYSE:MMM) are at the high end of their historical valuation range, but this is also the point of the business cycle when such companies have normally outperformed, and Citi analysts Deane M. Dray and Matthew W. McConnell expect the sector to hit a “fifth earnings season” heading into 2014.
“The sector typically outperforms in the late cycle/Steady Growth phase of the economic cycle. Yes, sector valuation has been pushed to the higher ends of its historical absolute and relative ranges, but fundamentals still look attractive. Upside from here should come less from multiple expansion and more from the expected 2014 earnings growth, fueled by better revenues from nonresi, stabilization in Europe, and backlogs.”
Absolute valuations are already quite high
While Dray and McConnell aren’t basing their recommendation on further ratings expansion, it’s still hard to get past the high valuations in this sector. Absolute valuations are already quite high, but what’s more worrying is the relative valuation. The last time the sector was going at such a high premium relative to the S&P 500 (INDEXSP:.INX) the rest of the market was in the doldrums.
“We remain in a Steady Growth period with energy end markets and construction markets increasingly contributing to otherwise lackluster growth,” they write. “Our positive sector view is predicated more on the assumption that the sector still has room to drive further earnings increases, and less from any meaningful multiple expansion from here.”
PE dispersion seems like a bad time to invest
Dray and McConnell’s bullish take on the multi-industry sector is in line with the overall mood on Wall Street, which expects to see sustained equities growth as the economy recovers, but many analysts have also warned that there is a good chance of a downward correction in the near term. Recommending a sector at the top of its historical range just reinforces that hardly anything is cheap right now, and an investor looking for a really good deal might just have to hang tight. Record high valuations and record low PE dispersion seems like a bad time to invest, even when other factors line up. For investors who also think that fundamentals are being propped up by QE more than most people like to admit, the timing couldn’t be worse.