- - Thursday, November 4, 2010

ANALYSIS/OPINION:

This past week was both an interesting one and for the most part one that turned out I would say as expected.

I’m referring to both Election Day and the formal announcement of what many have come to call QE2, or Quantitative Easing Part 2, by the Federal Reserve. On the former, the Republican victory in the House was no surprise for anyone following both the polls and pundits prior to Election Day. Many knew the Senate was going to be more of a challenge, but the Republicans managed to narrow the gap considerably.

QE2, on the other hand, was largely expected to come in near $500 billion or more, and Federal Reserve Chairman Ben S. Bernanke did not disappoint, announcing that the Fed would buy $600 billion in government bonds by the middle of next year. As I discussed last week, this is the latest attempt by the Fed to breathe new life into a struggling U.S. economy.

Clearly, we are not out of the woods. If we were, as the argument goes, the above two events would not have been necessary. As the cheers and hurrahs fade, we still have to look at what is going on around us, and that points to what I can best describe as a mixed picture.

Earlier this week, the Organization for Economic Cooperation and Development (OECD) cut its 2011 growth forecasts. More specifically, the OECD reduced its outlook for the U.S. with the gross domestic product (GDP) and now projects the annual rate to grow in the range of 1.75 percent to 2.25 percent compared with the prior 3.2 percent. For all its 33 members, the OECD cut its 2011 GDP forecast to a range of 2 percent to 2.5 percent, from 2.8 percent. All was not doom and gloom at the OECD — its revisions still point to growth in 2011, and reading further in its forecast one finds that growth accelerating in 2012. For 2012, the group expects GDP growth in the OECD area to accelerate to 2.5 percent to 3.0 percent and for the U.S. economy it sees even better growth in 2012, with GDP forecast to grow between 2.75 percent and 3.25 percent.

As I have mentioned many times, the actual numbers in these types of forecasts mean far less to me than the direction. I say this because the economy can be a tricky thing to watch as it can slow down far more quickly than one expects, much as we saw in 2008 and 2009, but it can also accelerate far faster than we might expect. That is why we as investors must always look for corroborating evidence. As it would turn out, we are seeing growth in certain parts of pockets of the economy, but weakness remains.

For the third month in a row, U.S. factory orders showed signs of growth as they rose 2.1 percent in September to $420 billion per Commerce Department data. I would note that this was better than the 1.6 percent widely expected. As with many of these statistics, there are several layers to them and we need to dig below the surface to really understand what is being put before us.

What drove the better-than-expected performance in September factory orders was a surge in demand for civilian aircraft and related parts. Excluding the often volatile transportation sector, new factory orders rose a much more modest 0.4 percent. Viewing the data another way, non-defense capital goods orders excluding aircraft, a barometer of business capital spending, fell 0.2 percent in the month.

As I said above, there are pockets of strength, and that means there are opportunities to be had if we look for them.

Rail traffic has been very good year to date with carloads up 7.3 percent over last year and intermodal loadings up an even stronger 14.6 percent on the same basis per the latest data from the American Association of Railroads. This has resulted in a firming outlook for not only the rail industry but for companies such as Trinity Industries Inc., American Railcar Industries Inc., the Greenbrier Cos. and FreightCar America Inc., which manufacture rail cars.

Unlike all the news flow on high-speed rail and related projects, the strengthening in the freight market has been essentially under the radar. The improving industry order flow has bolstered backlog levels and should lead to rising production levels in coming quarters as well as earnings growth and earnings multiple expansion, both of which bode well for the shares in those respective companies.

As someone who has watched this sector for some time, it appears we are in the early part of what will likely be an up cycle in freight car demand. Again, I don’t put much credence in actual forecast numbers but the directionality of a forecast in which Economic Planning Associates upped its freight car production estimate for 2011 from 19,800 units to 22,500 units, with more substantial growth beginning in 2012.

Good hunting.

Chris Versace, the Thematic Investor, is director of research at Think 20/20, an independent equity research and corporate-access firm in the Washington, D.C., area. He can be reached at cversace@washingtontimes.com. At the time of publication, Mr. Versace had no positions in companies mentioned. However, positions can change.

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