NEW YORK - Strong economic data on the manufacturing sector helped boost U.S. industrial shares in early trading on Tuesday, amid optimism the sector's earnings bottomed out in the second quarter and are set to improve.

A measure of the manufacturing economy by the Institute for Supply Management (ISM) moved above 50 last month for the first time since the recession began, showing manufacturing activity at its strongest level since June 2007.

Manufacturers also offered evidence of sustained recovery in China and signs of stability in Europe, indicating a global upturn from the worst recession since World War Two is taking hold.

A measure of industrial stocks .GSPIC gained 2.6 percent. United Technologies Corp rose 1.5 percent to $60.28, 3M rose 0.8 percent to $72.65 and Caterpillar gained 2.4 percent to $46.41. All are part of the Dow Jones industrial average .DJI.

I feel more positive about our business than I did six months ago, Kirk Hachigian, Chief Executive of electrical products maker Cooper Industries Ltd, told an industrials conference in New York on Tuesday. The worst is definitely over.

Since hitting its lows in March, the industrial stocks index is up 70 percent, versus a 49-percent advance by the S&P 500 .SPX.

REASONS FOR CAUTION

But analysts have said downside risk to earnings remains.

History offers reasons for caution, according to data compiled by Morgan Stanley. The ISM index topped the 50 mark four times between April 1990 and July 1993 before a recovery took hold. Capital spending took three years to rebound after recessions in 1990s and earlier this decade.

Commercial construction indicators are still contracting and capacity utilization rates are still near record lows, and cancellations of large transport and energy projects are rising, according to Morgan Stanley.

Meanwhile, among machinery companies, a ratio of inventories to sales is at record highs, Morgan Stanley analysts said in a research note on Monday.

For example, in the second quarter, Terex Corp sales dropped 55 percent but inventories only fell 21 percent. Caterpillar posted a 43-percent sales decline while inventories fell 14 percent. Sixteen other machinery companies also have room to cut inventories.

The recovery is going to be bumpy, said Tim Hanley, Deloitte vice chairman, who heads the U.S. Process & Industrial Products Group. He said industrial executives were optimistic about recovery, but they have not yet seen improved sentiment translate into new orders. (Reporting by Nick Zieminski; Editing by Derek Caney)

China U.S. Investment Morgan Stanley