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Industrials Sector Rating: Marketperform

By

Brad Sorensen

photo
CFA, Managing Director of Market & Sector Analysis, Schwab Center for Financial Research

Brad Sorensen heads market and sector analysis for the Schwab Center for Financial Research and writes for several Schwab publications. He is a member of Schwab's Investment Strategy Council.

Before joining Schwab in 2004, he was a senior analyst at AMG Guaranty Trust, where he designed portfolio strategies for high-net-worth individuals. Sorensen graduated from the University of Colorado with a bachelor's degree in finance and master's degrees in business administration and finance. He is a Chartered Financial Analyst charterholder.

October 11, 2018

Member for

1 year 8 months
Submitted by satya.billa on Thu, 10/11/2018 - 14:00
Industrials Sector

Industrials sector overview

Global manufacturing improvement appears to have leveled off, while U.S. manufacturing remains in expansionary territory. However, concerns about a trade war could put a damper on the group, although the tax cuts should help to dampen that potential disappointment.

Market outlook for the industrials sector

Global manufacturing has shown improvement although the rate of improvement, as would be expected, appears to be flattening out, with recent Purchasing Managers’ Index readings in most major countries staying in territory depicting expansion. Europe has slipped modestly but remains in positive territory. However, trade issues have flared up that could threaten the profitability of this very globally oriented sector, with 45% of the sector’s revenue coming from foreign sources, according to Strategas Research, although the recent agreement between the European Union and the U.S. to freeze further tariff hikes and discuss freer trade was a positive development. We continue to be encouraged that sides are continuing to negotiate, but don’t completely discount the possibility of an escalating trade war, especially with China, and the continuing rhetoric has the potential to dent the performance of the sector.

In the U.S., the Institute for Supply Management's Manufacturing Index remained quite strong in its October release, easing slightly from a 14-year high to a still-high 59.8 reading, while the forward-looking new order component posted a strong, 61.8 reading, showing little impact from the trade disputes to this point. Anything above 50 means an expansion in manufacturing activity. However, there were hopes at the beginning of last year that fiscal stimulus would be forthcoming and those hopes appear to be diminishing with the rancor in Washington, which has the potential to be a temporary weight on the group, but this may be an area where agreements between the two parties are possible following the midterm elections—although we aren’t holding our breath!

Overall, we have concerns but they're somewhat balanced out, which results in our relatively neutral view.

Factors that may affect the industrials sector

Positive factors for the industrials sector include:

  • Potential productivity gains: Corporate balance sheets remain relatively cash-rich, which should help push management teams to invest in new, more-efficient equipment to help offset weaker productivity.
  • Room for growth: Relatively low manufacturing inventories signal the possibility of a demand-inspired rebuilding phase.
  • Accommodative monetary policy: Excluding the Federal Reserve, central banks throughout much of the developed world are maintaining accommodative policies aimed at stimulating economic activity. Additionally, on the fiscal side, countries are considering undoing some of their more stringent austerity-related policies, which could help to boost economic activity and demand for industrial goods.

Negative factors for industrials include:

  • Fiscal austerity: We continue to watch fiscal austerity measures around the world, which could dampen growth in the industrials sector. For now countries seem to be moving to scale them back.
  • More aggressive Fed action: Should inflation start to reach concerning levels, the central bank could raise rates more aggressively, which would likely dent industrial shares.
  • Trade concerns:  As trade dispute rhetoric ramps up, concerns are growing that a damaging trade dispute could ensue.

 

Clients can see our top-rated stocks in the industrials sector.

Want to learn more about a specific sector?  Click on a link below for more information or visit Schwab Sector Views to see how they compare.

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