SCOTT DAVIS: My name is Scott Davis. I run a company called Melius Research, which
is a boutique research investment house that was founded about 18 months ago, a bunch of
ex-Morgan Stanley and Barclays senior folks. And we focus on industrials and data analytics. We focus on industrials research. And industrials, when you really think about
is it is the oldest sector in the S&P 500. It is battle tested. It’s been around for over 100 years. GE was the original industrial, if you want
to call it, then it actually was thought of as really a tech company back when it was
founded back in the late 1800s. We focus on industrials research, because
it’s central to almost every major economy in the world, particularly when you go into
emerging markets where industrial economies tend to equate to extraordinarily large amounts
of GDP say, two or three times that is as important as the US. We follow a lot of macro data, we look at
an awful lot of just reams of data, most of which is macro, some of it is micro, some
of it is proprietary, really to glean- have a view at least about the economy overall. And then what sectors make the most sense
to invest in any particular time. And, of course, as I said, our expertise is
in fact, in industrials. Generally, we’re bullish on the industrial
cycle and the cycle overall, the business cycle. What we see really playing out in the next
several years is a return to investment in developed markets. So, when you really think about the last 20
years, every incremental dollar of capital has been spent, predominantly in emerging
markets. We see that reversing. Now, more money coming back to and particularly
the US, to a lesser extent, maybe Europe. But really, the US is the place that we’re
most bullish on. And then the countries around the US, like
Canada and Mexico are certainly beneficiaries as well. When we think about that incremental dollar
of capital spent in the US, the best illustration I’ll give you why this is important is that
when US companies sell into a country like China, there’s typically selling into a region
with a ton of competition. You’re competing against the Japanese, the
Koreans, the Europeans, on average, you might capture maybe 15% market share. When you sell into the US market and on your
home turf, your market share may be as high as 30% to 50%. So, every dollar of capital that comes back
from being spent in an emerging market to a country like the US has really a multiplier
effect on the companies that we follow. And when I talk about companies we follow,
it could be everything from 3M to Emerson, to Honeywell, even we cover aerospace. So, companies like Boeing, for example, which
obviously has some challenges right now. But longer-term, big picture is fairly bullish
overall. So, that’s the way we look at it that as far
as what inning we are in the cycle- we think we’re probably in the general business cycle,
we’re probably in the seventh inning. In the industrial business cycle, we think
we’re probably more like the fourth inning. So, I wouldn’t call it early cycle, but probably
more like midcycle. And we think we’ve got several really good
years in front of us on the industrial side. What we learned in 1Q is that the business
cycle, the things that we just referenced as far as being bullish longer-term are actually
playing out. Investment is being made in the US. And that investment could be as simple as
supply chain, things like warehousing and stuff like that, to actual factories, to automation,
to robotics. We’re seeing that spend. What we are seeing on the other side of it
is a real slowdown in emerging markets, in particular China, and particularly the Chinese
consumer. So, when you think about the Chinese consumer
who has been just buying car after car for the last several years, auto sales have been
through the roof. Auto sales, for example, right now, we’re
seeing is really, really weak. So, our investment case, as far as money coming
back into the US is playing out in real time, we’re seeing that for sure. We saw that in the results. The companies that were more levered to the
Chinese consumer were the companies that really struggled this quarter the most. So, like 3M is our most global company. And it’s about 35% emerging markets and really
struggled this quarter because those markets in particular are weaker. The companies that are more focused on the
US and more focused on what we call later cycle things which are more project and capital
spending type activities. Companies like Honeywell. Those are the companies that that gave us
just fantastic results in the quarter. And we think that’s going to continue, really
for at least the next year, maybe up to three years. The other thing we get excited about industrials
are mega trends. And when I think about mega trends that influence
industrials the most, it would be things like electrification. So, you think about electric vehicles, which
in itself is amazingly exciting. But even further than that, it’s just the
electrification of the world. You go from a world that is burning a lot
of coal to solar and wind and other more environmentally friendly technologies. Each of those technologies benefit the industrial
world, if nothing else, because you need to spend money around them. You need to spend money to fix the electrical
grid if you’re going to put solar and wind on, you need to build new factories if you’re
going to build electric vehicles. Just look what Tesla has done out in California. And look at some of the electric vehicle launches
that we’re seeing even from like General Motors and Ford, they required new plant and equipment. They required new robots and I’ll just call
it new capital period. And that investment benefits us tremendously. The other thing that excites us is infrastructure. And I don’t think it’s going to come as any
surprise to anyone when you look across the US and just see how old our infrastructure
is. And I don’t care whether you’re talking about
our highways, or rail or airports, whatever. And we haven’t built a new airport. And gosh, I think it’s like 45 years or something
the last new airport that was built in this country, bigger part at least was in Denver. All of that stuff needs a huge investment. And so, when out of Washington, I talk about
a $2 trillion infrastructure plan. I think that eventually you’ll see money being
spent out of the federal government. We almost don’t need it because the private
sector itself will start to invest heavily in the infrastructure because it just has
no choice. That is also just extraordinarily bullish
long term for industrials. The other thing we’re excited about is global
air travel. And when you think about the population in
emerging markets of which so many people are getting on an airplane for the very first
time, and you’re rather than taking an eight hour boat ride between different islands in
Indonesia, for example, or the Philippines, jumping on an airplane for a 30-45 minute
John is just so much more practical. And I think once you do that, you’re unlikely
to go back to the methods of transportation that you’re engaged in before. So, when we think about global air travel,
that’s an exciting theme as well, which will also require spending. It will require spending on new airplanes,
and we’ve seen very strong orders for Boeing and Airbus, really the only two aircraft manufacturers
in the world. And will need new airports. And when you talk about new airports, airports
need a lot of electrical wiring and lighting and air conditioning and security systems
and all kinds of stuff that our companies sell. So, that’s another theme that I think we’re
really excited about. When we think about industrial companies,
we think globally. It’s tough to have a conversation about Boeing
without talking about Airbus. It’s tough to have a conversation about Caterpillar
without talking about Komatsu. It’s tough to talk about Emerson without Yokogawa,
which is a Japanese Process Automation player that competes against Emerson. It’s a global industry. When you look at the US players and the European
players, their footprints are pretty similar. And normally, what we see in in a global industrial,
in the average global industrial, let’s just say a Honeywell, for example, would be revenues
of about 50% in the US, call it 25% in Europe and 25% in emerging markets, some mix roughly
about that ballpark. So, it’s not good enough just for the US to
be strong for our average industrial company to do well. The world needs to be relatively healthy. You can’t be in a recession in the rest of
the world and still be okay in the US for more than maybe a couple quarters, which I
think we’ve seen some of that lately, where the rest of the world is slow, while the US
is strong. We would expect the rest of the world to perk
up and we’ve seen signs of that already. But it really is a global industry. Folks compete globally. It is largely consolidated because industrials-
and talking about industrials goes back 100 years. You have major conglomerates, big successful
great companies like Siemens in Germany, for example, or Schneider, Air France and competing
against companies like GE in the US and Mitsubishi in Japan. These companies have had literally 100 years
to consolidate their competitors and their supply chains and things like that. And so, generally, industrials are much more
consolidated than most other sectors out there just primarily because it’s just been around
a long, long, long time. One of the things that we’re really excited
about is technology moving down to the factory floor. And I think most people are comfortable or
at least aware of what a robot is. But robotics technology has come a really
long ways. And I’ll just give you an example, a traditional
robot was something that was put in a cell somewhere that had to be far away from people
because it could whack you in the head or generally could be dangerous if it was moving
and somebody didn’t pay attention. Now, they have things called cobots, which
are basically robots that will stand right next to you on the factory floor and help
you so maybe instead of bending over and having to pick up something and put a part together,
let’s just say on an auto plant, you could stand next to that robot and the robot could
really do the heavy lifting and all the difficult stuff for you. And maybe the person just make sure that it’s
done right in positioning and such. So, that change is massive, because when you
look back 20 years ago, jobs went to places like China, purely because of labor costs. And when folks put factories into China, they
did not automate them, or they automate them just a little bit. When you think about bringing jobs back to
the US and factories back into the US, you need to do so in a reasonable cost basis. And how we think about it is if you can take
50% of the jobs out of a traditional factory, and put it in the US, you’re pretty much at
cost parity with that same factory in China. The only way to take those jobs out, though,
are with robots and general automation. And so, we think companies like Rockwell Automation,
for example, which is one of the leaders in automation are really exciting for us, because
these factors just have to change. They need to become more productive, more
efficient, quality control needs to be higher, and they need to move closer to the supply
chain, which means closer to the customer. And if that customer is in the US, then you’re
more likely to build that product in the US going forward versus building it somewhere
else, and then shipping it all the way across the world. So, I think those developments are exciting. It’s still early days, but the technology
is moving really rapidly from what we’d characterized as the consumer electronics boom that we’ve
seen in the last 10 years or so to something similar we think is going to happen on the
factory floor, particularly around connectivity and IoT, that could just completely change
the way that companies make products going forward. It’s actually a great question around what
are the competitive threats as automation proliferates? And what we’ve learned at least is, and gosh,
I’ve toured hundreds of factories in my life. And what we’ve learned is that that domain
knowledge is still critical. So, it’s really hard people come to us and
say, okay, we don’t understand why Microsoft or Oracle hasn’t come down to the factory
floor more aggressively and taken market share from some of the traditional automation guys. And the reality is, is that each individual
customer type has its own processes and their own nuances. So, pharmaceutical, for example, has its own
needs versus the auto industry versus consumer electronics, if you’re making an iPhone, for
example, is going to be way different than making a biologic like Humira. That domain knowledge becomes really critical. And that’s the main barrier of entry from
the tech industry coming in aggressively into the industrial world. What needs to happen, though, and what we
think will happen are more partnerships. So, for example, we do see situations where
like Rockwell Automation has a tremendous partnership with Microsoft, because there’s
technologies they both can bring to the factory floor together that are more powerful than
going separately. When we think about picking stocks, we start
thematically. What are we excited about? We talked earlier about being excited about
capital spending, automation, electrification, some of these mega trends, then you bring
it down to the individual stock level, it gets a little bit muddy or a little bit more
difficult. We are super excited about Rockwell Automation,
because it’s a pure play automation company and the factory floor just exceptional company. We’re excited about Emerson. Emerson is about two thirds to three quarters
automation now. It’s almost a pure play. It has some other businesses but huge automation
business. Honeywell plays to these themes, not just
automation, but also other capital spending themes and has a large aerospace business
that we’re bullish on. Those are three names that come to mind on
the automation side. When we think about electrification or TE
Connectivity, maybe a company that not a lot of folks have talked about, it’s not a household
brand. But TE Connectivity is a company that makes
all the connectors and little electrical widgets that go in and in an electric vehicle. And that’s exciting to us as well. So, there’s several names to play- everything
I think we’re recommending stock wise plays into a capital spending theme in some way,
shape or form. I want to think about my colleagues at Melius,
some of the stocks that they’re excited about- Carter Copeland, who does aerospace for us,
loves Boeing. He loves buying Boeing in this pullback that
we’ve had here, because he believes in the dynamics around global air travel and the
demand for new airplanes over the next long term more than five years, 10 years as folks
travel more. My other colleague Rob Wertheimer is super
excited about the technology advancements being made at companies like Trimble, for
example. And the value that you get in buying a Caterpillar
because when you think about infrastructure span, you really can’t do that without moving
dirt. And Caterpillar is the best dirt mover in
the world. So, those are a few stocks we’re excited about. There’s others smaller down the market cap
that you can play that maybe provide some more upside things like Rexnord, a company
probably not a lot of folks have heard about. ITT, which is another one that’s relatively
small, but exciting as well. So, when we think about the stocks we don’t
like, it’s really just the inversion of what we’re recommending, which is if we love capital
spending, that largely means we don’t love stuff that’s going to be shorter cycle, more
flow goods, that the poster child or that would be a 3M. And 3M is struggling right now. It is a world class company. It’s a fantastic company. But we just don’t see the demand for their
products right now. That’ll change in a couple years as things
cycle in and out. They’re also more exposed to emerging markets
than other companies that we cover. And again, we would we would prefer to have
more US based exposure. And as much as you can get it, most of our
companies are global, of course, but less global. Generally, I think anything that is it is
shorter cycle, more flow goods, we’re going to be less bullish on. Not outright bearish, I would say in anything
just because the industrial economy is still in its relative infancy compared to the consumer
economy, and they were just now a couple years, I think we’re seven quarters into an industrial
up cycle. That’s really not much at all, compared to
the general business cycle, which is now a solid, eight, nine years in the making. When we think about the global macro picture,
and first of all, just the elephant in the room is just debt. There’s a tremendous amount of sovereign debt
out there. It doesn’t matter what country you look at. The countries have just been piling debt upon
debt upon debt. That’s the biggest systemic risk that we have
right now, overall, and we do lose some sleep over that. Because it does call into question our view
that infrastructure spend has to happen, yet we have a lot of government debt. So, how do you fund it, etc.? Do you do it with the private sector as public-private
partnerships? We’ll see as we get there. What we do know is that the money needs to
be spent, we think it will be spent, how you pay for it is going to be a little bit more
challenging, but I think we’ll probably just end up accumulating more deficits to get to
that point. When you just look around the world, the US
right now is the biggest beneficiary of everything that’s going on out there. Some of it is because of the tax bill. The tax bill is relatively unpopular. We all know that. However, the tax money that our companies
are saving, we’re now starting to see transition from largely going into buybacks to actually
going into capital spending. So, we’re actually seeing a fairly large investment
cycle, playing out with the tax savings. That’s going to help a lot. Some of that will be internal investment,
like R&D, some of that will be actual capital investment. Some of that will be infrastructure-type investment. We’ll learn more over the next couple years
is that money is being spent. But overall, the US is the biggest beneficiary
of that. When you look at the rest of the world, it’s
hard not to be bullish on Mexico, just given the proximity of the US, what’s going on in
the US and the fact that Mexico still provides relatively cheap labor and lots of product
can be made there and easily shipped up into the US. Canada, to a lesser extent doesn’t offer cheap
labor of course, but Canada as a trading partner is critical to the US. So, North America overall, look solid. Europe is a little squishy. I think on the capital spending side, it’s
okay. On the consumer side, its weak. Auto sales are stumbling here. And the consumer confidence is relatively
low. But we think we’ve hit a bottom there. China is a tough one. China, we are long term bullish on just because
I think the country itself is in relatively decent shape from a competitive dynamic. Lots of good, startup and emerging Chinese
technology companies that are interesting, and I think they’re going to help drive that
economy for years to come. I think the consumer is now completely addicted
being a modern-day consumer. So, what we’ve grown accustomed to in the
US, I think the Chinese consumer is rapidly adapting. So, I think China will be fine. But we’re going through a rough stage there
right now. And I think that’ll come out probably in the
back half of the year. Other countries around the world, Venezuela
is a mess. I’d like to be able to say that we get stability
there at some point, I’m not sure you ever will. Brazil, the same. It’s always the great hope that Brazil is
going to be this fantastic emerging nation in the world and just always seems to falter. India is another important region for us. And I think India looks really, really solid. And most of the rest of the world doesn’t
really move the needle for us anymore. Russia, for example, the Russian economy is
just too small globally to make much of a difference. But generally, we think emerging markets are
coming up and bottoming out and will come up in the back half of the year. Europe is stumbling right now. And I think Europe also will show some improvement
in the back half of the year. The US is the loan growth engine of the world. Throughout North America, not just the US
and we think that’ll continue. The tricky part is, is that if we’re wrong
and emerging markets don’t turn up, then the US can’t be the loan growth engine in the
world forever. It can certainly do that for a couple quarters,
but not forever. So, that’s the risk. We think those risks are we’re taking now. Business cycles, and largely because somebody
does something stupid. And that somebody could be the Fed, they could
over tighten. And I think the risk of that at this point
is relatively low. I think the Fed was late- certainly, very
late and seems to be in a permanent pause, or at least a pause. Right now, that’s relatively constructive
for our themes. We mentioned government debt earlier. And we’re still concerned about the levels
of government debt out there. But when you balance that against debt levels
on the average company out there, aren’t that high and the debt levels at the consumer level
aren’t that high. So, government debt is high, but the rest
of the system seems to be relatively healthy. We lose sleep over things that we can’t control. And those things you can’t control are the
911s of the world, the bubble bursting. The housing bubble that burst in 2008, and
the Lehman bankruptcy, those were catalysts that drove the economy down. And what typically happens is that event,
whatever that event is, causes a collapse in confidence. And as soon as you have any real hit to confidence,
then all of a sudden, these projects that we’re talking about, get delayed and potentially
cancelled. So, if you look back at 2008, for example,
are the best call that we made in my career, we downgraded industrials to a cell in April
2008. And we were several months ahead of really
the general macro. And the reason for that is that we were tracking
World Bank database that showed that projects went from green light to yellow light on its
way to red light really fast. So, we attract about 40 big global projects
that were well-financed and seemed to be progressing quite nicely, that all of a sudden hit delay. They were delayed either because of financing
risk, or just general confidence. To bring that back home. For example, one of those big projects was
in Las Vegas, it was the city center, I believe it’s called huge multibillion dollar spend
that was going on in Vegas in early 2008.By mid-2008, that project was being shrink wrapped. Literally, they stopped construction and they
put tie back wrap. They put tie back wrap around the thing and
just completely sent all the workers home and just shelved it. It’s stuff like that that causes a virtual
collapse in the system. So, anything that would really impact confidence
is something to watch for. Could it be the presidential election next
year and an outcome that business leaders don’t like? Sure. Political politics normally don’t play into
it as much, it’s normally some other black swan event just because it’s something that’s
really hard to predict. Gosh, we could predict those things, we’d
have a different career, I think. It would be quite amazing. And you just can’t. What you have to do though is position yourself
so that if those events happen, you’re not going to get completely blown up. So, we generally tend to favor the higher
quality companies that we cover that address the themes that we want to address but perhaps
address them in a less dynamic fashion, meaning just less risky fashion. One of the pushbacks we got an industrials
is aren’t we late in the business cycle? And when we think about the business cycle
versus the industrial cycle. We think of them as completely two different
buckets. Industrials overall represent about 10% of
the S&P 500, represents about 10% of GDP. If you go back and look at the industrialization
of America after World War II, those were multipliers of that, industrial economy mattered
a lot more. We think the industrial economy can actually
do very well, even if the other economy if you will, the consumer economy and everything
else related to that slows down, largely because what you might see here- what we think you’d
see in a macro slowdown, is a government come in and spend money on things like infrastructure,
and that directly benefits us. So, over the last 20 years, we’ve seen increasingly
a dislocation between the industrial in consumer economies and the general economy overall. And I think that’s gotten a little bit lost
in translation of why and how sustainable that is. And our view is at least that the industrial
cycle being much later and having far different drivers and dynamics and secular trends and
mega trends, like electrification that I mentioned, the industrial economy may actually do very,
very well, even in a mild recession overall. There’s a couple things to remember, I think,
with industrials. One is that you want to buy them on pullbacks,
you generally want to buy weakness. A company has a bad quarter, for example. You normally want to be and you still- like
the themes, you normally want to be a buyer of that, not a seller. It can be an emotional group where stock swing,
for example, 3M dropped 13% this quarter on its earnings day and has had a tough year. But generally, you want to be buying those
types of dips. Even though 3M isn’t one of our preferred
names right now, it is an industrial name that’s pulled back a lot. Overall, I would say that we are really excited
about these megatrends. Again, whether its environmental, whether
it’s electrification of the world, whether it’s infrastructure, robotics really bringing
jobs and factories back and the supply chain back to places like the US that can become
competitive from a manufacturing perspective again. These are all longer-term trends that I think
are going to take at least a decade to play out. There’s going to be cycles, there’s going
to be times when these stocks are out of favor and in favor. Generally, what we’d say is you want to buy
them when they’re out of favor. We saw that in in December and January, for
example. Stocks started come back in January and had
a pretty good start of 2019 overall. I think industrials is the second-best performing
sector in the S&P year to date, and we would expect that performance to continue.

8 thoughts on “Automation, Robotics & The Macro Case for Industrials (w/ Scott Davis)”

  1. After being bearish on the world economy and especially the US (when the feds started injecting hundreds of billions) it’s refreshing to see an optimistic perspective

  2. Turned this off when the bald guy suggested that adopting electric cars would reduce our reliance on coal. He is so clueless. No a clue. BAD.

  3. so ism cratering no big deal then, and in Germany same thing…the whole system is going bankrupt. who's going to spend…buy backs are still at an all time high btw. thats where your taxe cuts went not investing in the future.

  4. Heavy industry companies are shrinking on the S&P 500. We are noticing a push towards renewable energy and high tech/medtech companies increasing their market shares. In an overvalued/overbought stock market we are most likely to hit a new recession. Will the financial system based on the stock exchange survive the future?

  5. Uhhh.. Reality check. Mexico is imploding. 98% of crimes are unsolved. The upper class and much of the middle class have fled to the U.S.. Mexico is approaching failed state status.

  6. Every video I watch next on Real Vision Finance makes me alternate between bullish and bearish viewpoints of the world economy. So many perspectives that all sound right lol

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