Our Outlook for the Industrials Sector

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The broadest indicators of the U.S. economy's health showed a conspicuous downturn in the fourth quarter of 2007. Real gross domestic product increased at 0.6% in the fourth quarter of 2007, down from a healthy 4.6% in the third quarter. Notably, the latest national data from the industrials sector, which usually moves in lock-step with the broader economy, has been holding up surprisingly well. Industrial production in January 2008 increased 2.3% from the prior year, consistent with the 2.5% growth reported for all of 2007. January's capacity utilization increased 0.4% to 81.5%, roughly in line with the average for 2007.

While warning signs of a weakening U.S. economy continue to mount, we think the overall outlook for the U.S. industrial economy is favorable for 2008, particularly in the aerospace, infrastructure, machinery, and agricultural supply sectors. Real GDP in the United States is clearly decelerating. In the fourth quarter, GDP increased just 0.6%, down from a healthy 4.6% in the third quarter. The weakest sectors were retail spending and residential housing. Signs of weakness in the industrials sector, which had been a bright spot in the economy, began to emerge in February. Industrial production fell 0.5% in February after increasing 0.1% in January. Capacity utilization also declined, falling 0.6 of a percentage point to 80.9% in February, the lowest rate since November 2005.

While we concede that industrial production in the U.S. is likely to continue to slide along with the rest of the U.S. economy, we believe that the financial performance of multinational industrial companies and some select industrial companies focused on growth sectors of the U.S. economy will outperform the market. We think diversified multinational industrial companies will benefit from two powerful trends: robust industrial expansion from emerging markets and the weakening U.S. dollar. In addition, we think a robust aerospace market and demand for international shipping will drive strong earnings among companies serving those markets. We think multi-industrials  General Electric (GE) and  Emerson Electric (EMR) are well positioned to benefit from these trends. We think  Terex (TEX) should benefit from strong construction demand and  Boeing (BA) should thrive due to continued robust global demand for aircraft. Finally, we think that the weak dollar will stimulate international shipping and international shipper  Expeditors International of Washington (EXPD) will be a major beneficiary of the trend.

Valuations by Industry
Overall the bottom-up price/fair value ratio for all the stocks in the industrials sector remains unchanged at 0.92 presently from the fourth quarter of 2007. However, selected sectors demonstrated material changes to their price/fair value ratios.  

Industrials Industry Valuations
Segment	Current Median Price/Fair Value	Three Months Prior	Change (%)
Aerospace and Defense	0.87	1.03	-16
Agricultural Machinery	1.01	1.00	1
Agriculture	1.23	1.12	10
Agrochemical	0.97	0.91	7
Aluminum	1.00	1.00	0
Automakers	0.87	0.98	-11
Auto Parts	0.86	0.95	-10
Auto Retail	0.73	0.84	-13
Building Materials	0.71	0.69	3
Chemicals	0.96	0.92	4
Construction Machinery	1.37	1.20	14
Diversified	0.81	0.87	-7
Electric Equipment	0.92	1.00	-8
Machinery	0.96	0.85	-9
Manufacturing--Misc.	0.94	0.85	10
Metal Products	0.89	0.88	1
Packaging	0.93	0.90	3
Paints/Coatings	0.91	0.96	-6
Plastics	0.76	0.83	-8
Recreation	0.85	0.81	5
Rubber Products	0.79	0.70	13
Steel Iron	0.95	0.93	3
Transport Equipment	1.32	1.05	25
Truck Manufacturers	0.67	1.00	-33
Data as of 03-14-08.

Truck manufacturers turned in the largest adjustment in price/fair value ratio. The group's price/fair value ratio declined to 0.67 from 1.00 in the fourth quarter as increasing gas prices and increased pessimism by consumers diminished the prospects for domestic economic expansion. Historically sensitive to changes in domestic aggregate demand, the stock prices of truck makers such as  Paccar (PCAR) and  Winnebago (WGO) experienced significant declines recently. The price/fair value of aerospace and defense companies has declined 16% to 0.87 from the fourth quarter. We attribute the decline to the drop in Boeing's price due to its loss of the $30 billion Air Force tanker contract along with the pessimistic outlook for all defense contractors. Makers of construction machinery have seen their price/fair value ratios increase significantly since the fourth quarter due to the announcement of a favorable outlook on the part of industry bellwether  Caterpillar (CAT) earlier this month.

Industrial Stocks for Your Radar
We continue to see a number of compelling investments within the industrial space at current valuation levels. In particular, we think the following names are worth putting on your radar screen.

Stocks to Watch--Industrials
Company	Star Rating	Fair Value Estimate	Economic Moat	Risk	Mkt Cap ($ Bil)
Boeing		$114	Narrow	Average	57.2
Emerson		$60	Narrow	Below Avg	38.6
Expeditors		$53	Wide	Below Avg	9.4
General Electric		$42	Wide	Average	374.4
Terex		$105	None	Average	6.0
Data as of 3-20-08.

 Boeing (BA)
The market continues to focus on the possibility of further development/production delays of its game-changing 787 Dreamliner, the first commercial airplane made mostly of lightweight composites. And while further delays are more likely than not (probably another three to six months), concerns over penalty payments and cost overruns are severely overblown, throwing by the wayside both the stability of Boeing's defense business--even considering the recent tanker contract loss--and the strong demand for its in-production commercial airplane programs.

 Emerson Electric (EMR)
Emerson is well positioned to benefit from the soaring demand for energy and infrastructure expansion in emerging markets. Process management and industrial automation represent 25% and 20% of total sales, respectively. As a world leader in process automation systems for oil and gas processing and industrial automation systems for industrial factories, Emerson now generates over 50% of its sales from non-U.S. markets. Its network power segment is also growing rapidly due to rising demand for data network backup systems in emerging markets.

 Expeditors International of Washington, Inc. (EXPD)
Expeditors is the performance leader among non-asset-based freight forwarding and third-party logistics providers. Expeditors derives revenues from air freight (37%), ocean freight (25%), and customs brokerage and other services (38%). Revenue growth is predominantly organic and has grown at a 17% compound annual rate during the past five years. Expeditors owns neither ships nor planes, focusing instead on arranging international shipping using its extensive global network, then employing other firms' assets to accomplish freight movement. Notably, Expeditors carries no debt.

 General Electric (GE)
General Electric is exceptionally well positioned to benefit from robust demand for infrastructure spending from emerging markets. Approximately 57% of industrial sales are generated from infrastructure-related products, including power generation equipment, oil and gas processing equipment, water purification systems, and jet aircraft engines. General Electric generates about 60% of sales from non-U.S. markets and exports many of its highly engineered products such as jet aircraft engines and power turbines from U.S. factories. As the dollar declines in value against other currencies, General Electric's products will become more price-competitive against those of competitors whose costs are denominated in currencies appreciating against the dollar, such as the euro.

 Terex (TEX)
Terex should not only benefit from continued operating improvements but also from its exposure to late-cycle end markets that are being propelled by a strong nonresidential construction environment--particularly overseas. From the  Analyst Report: "Terex has minimal exposure to the U.S. housing market (5%-7% of revenue), and its late-cycle businesses (such as the crane business) are just starting to heat up. While a cyclical slowdown will eventually ensue, we think an acute focus on costs will allow Terex to create shareholder value throughout the economic cycle."

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