How the cycle links Taiwan, Google, ball screw sales and Greece

by SR on February 13, 2012

Related stocks: Hiwin Technologies (2049 TT); NSK (6471 JP); Okuma (6103), Mori Seiki (6141), Amada (6113), Denso (6902 JP); Bridgestone (5108)

  • Fully discounted? Obscure Taiwanese machinery parts supplier Hiwin has seen its monthly sales crater over the past few months, yet the share price is up 60% in just a few weeks. That strikes me as symbolic of how the market is beginning to view the machinery/capex cycle.
  • The potential bull trap. So is the bad news all in the price for industrial stocks? My concern would be that if the European issue is not resolved and we go back into “risk-off mode”, cyclical stocks will suddenly become as attractive as rotting fish.
  • Of Greece and Google. To test the linkage between the European problem and the performance of the major markets I plotted the frequency of occurrence the phrase ‘Greek crisis’ in Google News against the performance of the S&P500 index. The results broadly suggest that the ability of the crisis to affect the US market is waning.
  • Still prefer tyres to industrials. If the European crisis is in the process of being resolved in a way that the markets like, I acknowledge that cyclical stocks are probably a buy. For the more risk-averse, I suggest looking at tyre stocks, particularly Bridgestone. Based on low rubber prices and solid shipments I think the company could rip past management profit guidance in FY2012.

Taiwan company’s monthly sales plunge, share price rips

On Friday evening I was having a drink or two with Ex-Machinery Guy, who used to watch the US machinery sector for a broker we both worked at. Ex-Machinery Guy saw the light and joined the buy side a while back; now he roams the planet in pursuit of attractive global industrial plays and esoteric single malts.

I mentioned to Ex-Machinery Guy that I had just been taking a look at Hiwin Technologies’ monthly revenues for January 2012. Hiwin (2049) is a Taiwanese supplier of ball screws that has been gaining share from Japanese suppliers, particularly NSK. Ball screws represent a narrower slice of demand than, say, bearings but they are used in a variety of machine tools so I consider them an indicator of demand for machine tools and related equipment.

There’s no mystery about Hiwin’s market share gains in my opinion. The ball screw business is not an especially important or lucrative one for NSK and so NSK was reluctant to add capacity. If you don’t grow with the market you lose share. The other problem for NSK was that as a result of restructuring plans drawn up during the global financial crisis in 2008, NSK ended up moving and consolidating its ball screw lines just when demand was strongest in 2010, which caused significant delays in shipments to its customers.

One of these normally discreet customers became so angered by these delays at NSK that they started complaining vociferously to visiting analysts and investors, which is when Hiwin first came to my attention. Hiwin’s annual revenues are about one-twentieth of NSK’s annual revenues but the chart below shows how rapidly Hiwin’s sales have risen over the past two years. The figure also shows how dramatically sales have fallen in the past two months. Up like a rocket, down like a stick, as the cheerful City saying goes.

Hiwin monthly sales

Ex-Machinery Guy was nodding his head as I ran through this, as people do when they have something they want to say. “Yeah, the monthly sales are awful” he countered, “but the share price is up 50% since the bottom”. That sounded like typical industry exaggeration to me but between us we managed to get a chart up on the smartphone to check. It looked like this.

Hiwin share price

Sure enough, the stock had plummeted from 396 NT dollars on 27 July 2011 to 201.5 on 26 September 2011 but as of Friday 10 February it was back up to 320.5 – an increase of 59%. Not only that, but the stock had already moved up from its lows to just over 280 then back down again to 220 between September and early January, which is when it began its latest run. (Say what you like about small-caps; at least the volatility means you’ll never get bored.)

“We own a chunk of that stock” said Ex-Machinery Guy, making a commendable effort not to sound smug. From this we moved on to the perennial discussion of the right timing to buy cyclicals. My view is biased towards caution, as noted in this post on poor Japan bearing orders and this other one on crumbling Japan forklift exports. Both are areas in which the Japanese have high market shares globally and so trouble here tends to indicate more than just a domestic demand problem.

Certainly markets are supposed to discount bad news early and anticipate profit recoveries. The conventional wisdom is that you have to buy when things are still looking bad; many have found that this approach can leave you high and dry if you buy too early. My concern is that over the past two years we have seen that even robust growth stories for individual stocks can be completely overshadowed when the markets go into “risk-off” mode. Effectively a bet on cyclicals is a bet that markets have got over the crisis in Europe and that we will not return to recent lows.

Is Europe’s poison at last losing its bite?

To evaluate in a not particularly scientific way the strength of the linkage between markets and media babble over Greece, I put together the figure below. In the upper panel I inserted a line chart showing the weekly frequency with which the phrase “Greek crisis” appeared in Google News from January 2010 to January 2012. The figures on the y-axis have been normalised and scaled by Google Trends, so it’s best to focus on the shape and timing of the curve rather than the absolute level. In the lower panel I put weekly price data for the S&P 500. I expected to find that media coverage of the European mess depressed share prices, but I was only partly correct.

Frequency of Greek crisis appearing in Google news vs S&P500 index

After the first substantial media coverage of the Greek crisis, the S&P500 index fell from 1212 in late April 2010 to 1022 in early July 2010, a decline of more than 15%. Then there was another spike of media interest in the Greek crisis in early July 2011 and the index went from 1340 to 1100 by early October, a fall of 18%.

However, since late 2011 the market has seemed to shrug off further media coverage and decided that – at least for now – the negatives are outweighed by other positive factors elsewhere. Since those October 2011 lows, the S&P500 has risen about 20% (calculated up to the end of January 2012).

This chart suggests to me that the power of media coverage of the European crisis to suppress the market may be waning. If that is the case, this in turn should mean a more supportive environment for stocks.

Not much of a window

So, the risk to my “wait and see” approach is that the shadow thrown by the European crises may be clearing, giving cyclicals some room to run. In my experience, when cyclically-inclined industrial stocks move, they move fast and hard. You might think that the move in Hiwin’s share price should be considered to mark one extreme of the spectrum, but it’s interesting to note that even Japan’s auto parts stocks (a relatively pedestrian group) posted similar gains towards the end of the 2008-2009 global financial crisis.

Take Denso, for example. On 5 December 2008 the share price bottomed at Y1,254 yen and by 7 May 2009 it had more than doubled to Y2,595. The share price dipped then rose again to reach Y2,945 in August, but that was a piffling 13% increase. The big money had already been made in the first few months from the bottom.

In other words, the window of investment opportunity for industrials and cyclicals, here today in February 2012, could be measured in months rather than quarters. If you miss it, you’ll likely underperform. Possibly I have already missed it.

Meanwhile, Ex-Machinery Guy thinks the time to buy has come and is busy stuffing his trousers with cyclicals. He may have a point. Whenever the markets are tanking and the light at the end of the tunnel seems not to exist, I take out and read again a quote that I first scribbled in my notebook more than a decade ago. It’s pure gold.

“When the pressure to sell is the greatest, that is when I start shaking my head and state, ‘It should hold here’. When I rush to the brokerage office a half hour before opening time to be sure I am there to watch the crash, when I feel my stomach turn and food doesn’t appeal to me, when the blood is rushing to my head and my breathing is a little short because I know I must make a decision, possibly to salvage what is left, when my broker’s voice is trembling, when the faces in the board room are full of fear, then, I have learned this is not the time to sell. THIS IS THE TIME TO BUY.”  (Edward S Jensen “Mass Psychology” quoted in James Dines, “How the Average Investor Can Use Technical Analysis for Stock Profits”)

There was plenty of doom and gloom in October 2011 so maybe that was indeed the time to buy. I’ll be interested to see whether, in a few months time, Ex-Machinery Guy is crying into his Ardbeg – or whether he’s laughing all the way to the bank.

 

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