Industrials Sector Rating: Marketperform

What is the industrials sector?

The industrials sector includes manufacturers and distributors of capital goods such as aerospace and defense, building products, electrical equipment and machinery. It also includes providers of services including transportation, construction, engineering and printing.

Industrials sector overview

Global manufacturing has begun to improve, although unevenly, while U.S. manufacturing remains in expansionary territory. However, a stronger U.S. dollar and a tepid European economy are potential risks to U.S. industrials companies.

Market outlook for the industrials sector

Global manufacturing has started to show some signs of life, with recent purchasing managers index readings in some countries moving out of contractionary territory. Europe, especially, is showing signs of at least modest improvement as some of the uncertainty regarding elections within the bloc has been resolved and PMI readings have improved. However, China is now showing signs of tightening monetary policy by issuing restrictive new housing regulations according to Reuters and raising a key interest rate. 

In the U.S., the Institute for Supply Management’s Manufacturing Index remained solid in June, moving to 57.8 from 54.9 the month before, while the forward-looking new order component posted a robust 63.5 reading. Anything above 50 means an expansion in manufacturing activity. However, potential renewed dollar strength could weigh on exports and eventually on production and earnings. That said, when the dollar strengthens because U.S. growth prospects are improving, as appears to be the case now, we think the hit to the industrial sector could be mitigated somewhat and we’ve seen dollar gains moderate recently, which should help the group internationally. 

Overall, we have concerns but they’re somewhat balanced out, which results in our relatively neutral view. China’s growth is sluggish by historical standards but still decent. India’s demonetization scheme has largely been completed, and we think growth can improve as confidence returns. And, as mentioned, a stronger dollar and an uncertain European economy are potential risks that have risen as of late.

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 implementing more 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:

  • Limited access to credit: This is especially the case among smaller businesses, and tends to dampen spending plans.
  • Fiscal austerity: We continue to watch fiscal austerity measures around the world, which could dampen growth in the industrials sector, but for now countries seem to be moving to scale them back.
  • Stronger dollar: A renewed strengthening of the U.S. dollar could hurt exports and dent U.S. industrial company profitability.

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

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