Schwab Sector Views: What Makes the World Go Around?

Key Points

  • The industrial sector is often overlooked but is at the center of much of what occurs in the global economy.
  • Improving global growth and a solid U.S. economy should bode well for industrials.
  • However, the diversity of the group and monetary and fiscal uncertainty keep us from upgrading the sector … for now.

Schwab Sector Views is our three- to six-month outlook for 11 stock sectors, which represent broad sectors of the economy. It is designed for investors looking for tactical ideas. We typically update our views every two weeks.

Technology and consumer discretionary companies are the sectors that tend to garner the most attention, and for good reason, as those areas touch many parts of all of our lives. Meanwhile, another sector that is vital to the workings of both of those sectors as well as the rest of the domestic and global economies seems to be somewhat ignored by many investors, given the limited attention it receives in the media and the lack of questions I receive on it.

The industrial sector is incredibly diverse and includes companies that touch virtually every area of the U.S. economy. It includes airlines, railroads, trucking, shipping, machinery, defense, and various other related areas.  The sector only makes up about 10% of the S&P 500 Index, but it appears to us to be punching above its weighting based on its potential impact on the economy. For example, as part of an online purchase, who provides the electrical equipment to process the order and the infrastructure to deliver the package … not to mention the machinery to make the product? The answer is likely from somewhere in the industrial sector.

So where does the sector currently stand? The group received a jolt following the election on hopes that the Trump Administration with a Republican Congress would be able to push through a major infrastructure package. Since that initial surge, as hopes of near-term stimulus faded, the group has lost some enthusiasm and has traded just slightly below the overall market’s returns year to date. But that market action can be instructive of what generally could push industrial performance forward—better economic growth translating into more spending on transportation, building, traveling, etc.

Even though past performance is no indication of future results, according to Ned Davis Research, the industrial sector has benefitted throughout history from such things as better consumer confidence, rising oil prices and better commodity prices—some of which we’re seeing signs of.

High consumer confidence could help industrials

Source: FactSet, Conference Board. As of Aug. 14, 2017.

As could higher commodity prices

Source: FactSet, Commodity Research Bureau. As of Aug. 14, 2017. China import Iron Ore Fines 62% FE spot.

Although oil injects a note of caution

Source: FactSet, Dow Jones & Co. As of Aug. 14, 2017.

Part of the problem with the sector is the diversity, although that can also be a benefit. It can be difficult to get the entire group moving in the same direction, making it somewhat difficult for us to make an outperform or underperform call on the entire group. For example, periods of rising oil prices, as noted above, have tended to aid the group in general, but can cause problems for areas such as airlines and trucking companies as their costs rise. But we are getting closer to boosting the rating on the group as global growth has shown signs of improving—as seen by rising Markit surveys worldwide as well as a rising OECD (Organization for Economic Cooperation and Development) leading economic indicator. Additionally, the sector gets roughly 45% of its sales from foreign sources, according to Standard & Poor’s, which means the group should benefit from a weaker U.S. dollar. 

Rising indicator bodes well for global growth

Source: FactSet, OECD. As of Aug. 14, 2017.

And a weaker U.S. dollar should help the industrial sector

Source: FactSet, Intercontinental Exchange. As of Aug. 14, 2017.

Finally, for now, the sector could receive a tailwind from an increase in defense spending, both here and around the world. President Trump has been quite vocal in his desire to increase defense spending and, with the increase in geopolitical tensions, there may be an appetite in Congress to go along with that goal. While that remains in question, Strategas Research reports that U.S. defense spending is already growing at its fastest pace since 2011. Globally, other countries are under pressure from the U.S. (based on speeches from the president) to spend more on defense, in accordance with their agreements as a member of NATO (North Atlantic Treaty Organization). We’re watching how both of these situations develop, but the potential for a tailwind certainly exists.

It seems to us that when the industrial sector starts to gather momentum, something happens to pull it back again. It’s this action, along with the uncertainty regarding U.S. fiscal policy and market reaction to the Quantitative Tightening likely to occur soon (according to the Federal Reserve), that keeps us from boosting the rating on the group. But we do suggest that investors that haven’t done so bring their allocations up to the market weight as part of a diversified portfolio, and continue watching this space to see when a boost may occur.                                                                                     

Schwab Sector Views: Our current outlook

Sector

Schwab Sector View

Date of last change to Schwab Sector View

Share of the
S&P 500 Index

Year-to-date total return as of 08/15/2017

Consumer discretionary

Marketperform

07/17/2014

12%

11.02%

Consumer staples

Marketperform

05/07/2015

9%

9.33%

Energy

Marketperform

11/20/2014

6%

-14.36%

Financials

Outperform

05/07/2015

15%

8.84%

Health care

Outperform

01/26/2017

14%

15.90%

Industrials

Marketperform

01/29/2015

10%

9.78%

Information technology

Outperform

04/29/2010

23%

24.73%

Materials

Marketperform

01/31/2013

3%

9.70%

Real estate

Underperform

01/26/2017-

3%

7.19%

Telecom

Underperform

09/12/2013

2%

-6.59%

Utilities

Underperform

05/23/2013

3%

13.71%

S&P 500®  Index (Large Cap)

 

 

 

11.49%

Source: Schwab Center for Financial Research and Standard and Poor’s as of 07/31/17.

Clients can use the Portfolio Checkup tool to help ascertain and manage sector allocations.

What is Schwab Sector Views?

Schwab Sector Views is our three- to six-month outlook for 11 stock market sectors, which are based on the 11 broad sectors of the economy.

The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:

  • Outperform: Likely to perform better than the rest of the market.
  • Underperform: Likely to perform worse than the rest of the market.
  • Marketperform: Likely to track the broad market.

How should I use Schwab Sector Views?

Investors should generally be well-diversified across all stock market sectors. You can use the Standard & Poor’s 500 allocations to each sector, listed in the chart above, as a guideline.

Investors who want to make tactical shifts in their portfolio can use Schwab Sector Views’ outperform, underperform and marketperform ratings as a resource. These ratings can be helpful in evaluating and monitoring the domestic equity portion of your portfolio.

Schwab Sector Views can also be useful in identifying stocks by sector for potential purchase or sale. When it’s time to make adjustments, Schwab clients can use the Stock Screener or Mutual Fund Screener to help identify buy or sell candidates in particular sectors. Schwab Equity Ratings also can provide an objective and powerful approach for helping you select and monitor stocks. 

Next Steps

Talk to Us
To discuss how this article might affect your investment decisions:
-          Call Schwab anytime at 877-338-0192.
-          Talk to a Schwab Financial Consultant at your local branch.

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