Every once in a while, stocks get too expensive or too cheap. As the market is a rough estimate of how the underlying United States economy is doing, any of the two extremes could signal that the FED is about to do something. When stocks crashed in 2020 during the COVID-19 pandemic, lower rates sent stocks flying; today, the script is flipped on you.
The big question everyone is asking today is: Will the FED cut rates in 2024 because something terrible will happen, or will something bad happen because the FED will cut rates. You see, low-interest rates typically create bubbles in certain areas of the economy while leaving otherwise attractive businesses behind. The good news is that, in this 2024 pivot, you only have to worry about one thing.
It is clear, by economic outlooks rolled out by one of the biggest names on Wall Street, that the manufacturing sector of the United States will likely see a breakout this year. Top that with a returning electronics industry demand, and you’ve got the perfect storm for stocks like Eaton (NYSE: ETN) to take over as one of the market’s favorites.
Why here, why now?
There is no perfect time to rotate into or out of a sector in the financial markets, but if it ever made sense to consider a rotation, now would be a good time. You see, today’s market is nothing like what you experienced in 2023, where growth was the only story around (despite how optimistic the promises were), and that is all about to change.
Over the past year, the manufacturing sector of the United States has been in a heavy contraction, as seen in the month-to-month trends in the ISM manufacturing PMI reports. This means that the only reason U.S. GDP kept growing was due to the services sector alone, but even the fundamentals there are drying up.
Suppose the FED wants to see jobs and activity come rolling back into the manufacturing space. In that case, it must act soon by lowering interest rates. Why? The value of the dollar is pegged in part to where interest rates are headed, so if rates are cut down, the dollar index could likely come down as well.
By bringing the dollar lower in the world market, American exports could become a more attractive purchase for foreign nations, which should spur massive activity for the overall economy. Now, who really wins in that scenario?
Unless factories still operate with machinery from the industrial revolution, most assembly lines and processes are aided by technology. Eaton just so happens to provide these companies with the industrial power distribution products to ramp up export production.
This is exactly the view that analysts at The Goldman Sachs Group(NYSE: GS) took in their 2024 macro outlook report, in summary, they are also pointing to a breakout of the domestic manufacturing sector. Alright, so the story makes sense, and it’s backed by one of Wall Street’s biggest names; now what?
Check the market
It is time to get a little translation going because you must have a specific reason to choose Eaton stock over competitors like Emerson Electric (NYSE: EMR), which are respectable in their own sense. You can start with two fundamental factors that have historically driven stock prices.
For starters, you can look at how Wall Street analysts are projecting earnings per share for a specific company, as the more growth is projected, the more a market is willing to come looking for justifications behind such a projection.
In that sense, if markets believe that the projections are reasonable and justifiable, buying the stock in mass will drive valuation multiples higher, such as the forward P/E ratio as the one that attempts to value tomorrow’s earnings.
So, where are these stocks in that spectrum? Eaton has better prospects than both Emerson and the rest of the electronics manufacturing industry on average. Analysts are shooting for 10.7% EPS growth in the next twelve months, above the industry’s 9.4% average.
Emerson analysts are showing some disappointing data here, as their projections suggest EPS growth of only 7.7% for this year, below the industry average. You can probably guess where the market is valuing these two stocks consequently.
Markets are willing to pay 24.6x forward P/E for Eaton, translating into a 37.2% premium above the industry’s average 17.9x multiple. For Emerson, its 16.8x valuation will discount it by 6.2% off the industry average. As the saying goes, it must be cheap for a reason; do you really want to risk your money just to find out what that reason is?
The macro is working in favor of Eaton, and both analysts and the broader market forces have left you with enough evidence to take home and consider whether a safe name with reasonable growth amid a new cycle is what you need to hold in 2024.
