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Industrials Sector Rating: Marketperform

Industrials sector overview

Global manufacturing activity has deteriorated as trade concerns have ramped up and dampened activity around the world.

Market outlook for the industrials sector

The industrials sector has rebounded a bit over the past month as trade hopes have been revived by an announced October meeting between the U.S. and China—illustrating why we remain neutral on the group despite the trade headwinds, as reversals are very possible. However, we’re not overly optimistic about the prospects for a near-term deal and that could threaten the profitability of this very globally oriented sector (45% of the sector’s revenue comes from foreign sources, according to Strategas Research). While the China situation has appeared to dominate, Congressional passage of the USMCA could be in trouble in this politically charged environment (Strategas).

Additional pressure appears to be coming from global growth concerns, as the Chinese Markit PMI has been weakening. However, in the U.S., the Institute for Supply Management® (ISM®) Manufacturing survey increased our concern a bit by falling again to 49.1 in August, while the forward-looking new order also fell, moving to 47.2 from 50.6, as manufacturers appear to be growing more concerned regarding the ongoing China-U.S. trade dispute..

Overall, our concerns are growing, but we are also aware that even a modest improvement in trade relations with China could result in a fairly sharp near-term rally in the industrials sector. In an attempt to balance those risks we are keeping our neutral rating on the group, but the sector is on downgrade watch should trade continue to worsen and economic growth deteriorate further.

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.

Negative factors for industrials include:

  • Reversal of recent Federal Reserve action: Should inflation start to reach concerning levels, the central bank could reverse course and be forced to reinstate rate hikes, which would likely dent industrial shares.
  • Trade concerns: The China-U.S. trade dispute has heated up, hurting manufacturing and pressuring the globally oriented industrial sector.

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Communications Sector Rating: Underperform
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Important Disclosures

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The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of Morgan Stanley Capital International Inc. (MSCI) and Standard & Poor's. GICS is a service mark of MSCI and S&P and has been licensed for use by Charles Schwab & Co., Inc.

Markit Manufacturing Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index includes the major indicators of: new orders, inventory levels, production, supplier deliveries and the employment environment.

The Institute for Supply Management (ISM) Manufacturing Index is an index based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries.

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