The Industrial Select Sector SPDR (NYSEArca: XLI), the largest industrial exchange traded fund by assets, is higher by more than 23% year-to-date and that upside could be extended if the Federal Reserve, as expected, proceeds with cutting interest rates at its meeting this week.
XLI “seeks to provide precise exposure to companies in the following industries: aerospace and defense; industrial conglomerates; marine; transportation infrastructure; machinery; road and rail; air freight and logistics; commercial services and supplies; professional services; electrical equipment; construction and engineering; trading companies and distributors; airlines; and building products,” according to State Street.
“All is not ideal for industrial stocks right now,” reports Al Root for Barron’s. “Several sectors, like those linked to cars and energy, are lagging the overall market. What’s more, global manufacturing is slowing down and valuation multiples are falling too. That’s why the impact of a Federal Reserve interest-rate cut on rust-belt industries is an easy call: It is positive.”
As an overarching theme, investors should consider how to position in the slowdown or late stages of the normal business cycle. The slowdown period is characterized by capacity utilization peaks, positive output gaps, positive but decelerating growth and more restrictive monetary policy. In this type of environment, investors may find that consumer staples, healthcare, and industrials tend to outperform, whereas materials, consumer discretionary, and real estate segments tend to underperform.
“But there are pockets of strength and pockets of weakness. Aerospace & defense stocks, for instance, are doing great, up 38% year to date. But auto makers and automotive part suppliers are up less than 9% year to date,” according to Barron’s. “And stimulus could help Wall Street’s mood too. Analysts are sounding less optimistic about industrial stocks lately.”
The sector’s performance this year is impressive when considering the headwinds faced by Boeing Co. (NYSE: BA) with the grounding of the 737 Max passenger jet and the earnings charge the company took as a result. Plus, Caterpillar (NYSE: CAT) and 3M Co. (NYSE: MMM), two other marquee XLI holdings, have recently their shares struggle.
Industrials perform well when interest rates rise because rising rates can go hand-in-hand with economic growth. Increased infrastructure spending is also seen as a catalyst for industrial stocks and ETFs. However, the sector’s recent performance indicates industrials are disappointing at a time when the sector should be thriving.
“Still, even if the trade environment doesn’t change, a rate cut will still be a benefit to the sector,” notes Barron’s. “At minimum, it should help industrial stocks keep up with the market in the second half of 2019. And a cut might even help push industrial valuation multiples back toward the broader market, giving the industrial sector a little extra boost.”
For more information on the industrial sector, visit our industrial category.