Second-quarter 2005 stock price performance for control and automation sector companies showed an overall flat performance through June, but look closer, and you'll see things were anything but quiet. Within the group, Badger Meter rallied ferociously following a strong 1Q earnings release in April. Through June 30, BMI is up 56% and in July rose another 25%. It doesn't hurt that BMI is nearly a pure play in water metering and management equipment—currently a hot area on Wall Street. On the other hand, several stocks showed double-digit declines, as April earnings releases didn't live up to investor expectations.

Overall, the Control Engineering stock index has recovered to nearly the all-time highs of December 2004. Compared to analysts' forecasts, 10 out of the 12 U.S.-based stocks in this group posted positive earnings surprises. However, investors are still somewhat cautious about the second-half earnings outlook.

Another observation is that share prices have been helped by an overall improvement in market sentiment. That's just another way of saying that the market is awarding itself a higher valuation despite no real change in earnings outlook. Why is that? We think the reason is that economic growth has proved to be a lot more resilient to concerns that weighed on 1Q, such as sharply higher energy prices as the Fed tightened credit. So far, so good.

Industrial capital spending ultimately drives the outlook for automation and control sector. Capital spending trends have posted a healthy gain so far in 2005, with the outlook getting better for the second half and into early 2006. Examples of this continued spending include: GM management reaffirms plans to spend $8 billion this year, up by $1 billion from 2004; Ford plans to spend $7 billion this year, up 10%, with manufacturing productivity improvements the goal; GE expects to spend $3 billion, up 25% from last year; and Honeywell plans to spend $800 million in 2005, up 27% from last year.

There are signs that 2006 will be another strong year for capital spending. A case in point is Parker Hannifin, a supplier of motion control components to an array of worldwide customers. In its new fiscal year, which began July 1, the company is nearly doubling capital spending to $270 million, to address long-ignored capacity bottlenecks and accelerate new product introductions.