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Schwab Sector Views

Schwab Sector Views: Conflicting Industrials

Key Points
  • The industrial sector represents much of the core of the American economy, but has struggled to gain much traction.

  • The diversity of companies in the group makes it somewhat more difficult to make strong pronouncements on the sector.

  • Investors should continue to hold a neutral position in industrials, but for those more tactical investors, digging into specific industries may yield opportunities.

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.

The yin and yang of industrials

The industrial sector has gotten a lot of attention since the 2016 election, and for good reason. The economy was a major factor discussed during the campaign season, and the victorious party made hay with the idea that tax cuts would boost economic growth and infrastructure and defense spending would increase. With such industries as defense, railroads, airlines and manufacturing equipment, it may seem that the industrial sector would stand to benefit from such development. And we did see a corporate tax cut that is still being digested, while economic growth seems to have ticked higher, according to readings from the Bureau of Economic Analysis, yet the industrials sector has underperformed the market modestly over the last 12 months. Why?

Industrials struggling to gain traction

While admittedly subjective, I believe that the industrial sector has one of the most diverse company mixes out of all 11 sectors. What positively affects one area of the group may have a direct negative impact on another—making it difficult to make a broad statement on the performance of the entire sector and resulting in our marketperform rating at the current time. Depending on what area of the sector an investor may be focusing on, that may seem either far too conservative or too aggressive. Certainly, better economic data and manufacturing surveys should, in our view, positively affect much of the sector as improved business confidence should help to bolster capital spending, some of which would likely come from areas of the industrial sector.

Manufacturing looking good …

As is industrial production…

And capex spending plans are elevated.

So what could be the downside to all that good news?  First, rising economic growth can result in higher energy costs, which would raise costs for the airlines directly and other industrial areas indirectly. Additionally, there’s the mix in Washington, where economic policies likely have helped to boost growth while also boosting the possibility of trade conflicts—with the Trump administration threatening to tear up NAFTA, while imposing tariffs on steel and aluminum imports, and warning that there may be more to come. With roughly 45% of the sector’s sales coming from overseas (according to data compiled by Strategas Research), trade disputes have the potential to cause a drag on the group. Also, the U.S. economy seems to be distancing itself from the global economy, which we believe has helped to boost the U.S. dollar, making U.S.-made goods more expensive for foreign buyers, and that also could negatively affect some of the industrial sector.

Global growth may be slowing …

Which has helped the dollar strengthen.

But wait, you may be saying—part of the tax reform package was a large incentive to bring money back to the United States that was held overseas, i.e., repatriation. And on its face, we believe that should help. But there is still uncertainty regarding how much money will actually come back and what companies are going to do with it. According to Strategas, roughly $2.6 trillion is held overseas, with estimates that around $1.7 trillion of that will be brought back relatively soon—yet companies have announced plans for only $465 billion of that money, and there may be more share-buyback and dividend-raising plans than had been hoped for by those bullish on the industrial sector.

Guns or butter?

OK, you may be saying, but what about aerospace and defense?  As the biggest industry in the sector (according to data from S&P) and with geopolitical risks elevated and a Republican, pro-defense mix in Washington, surely that can push the sector higher. In fact, aerospace and defense is the second-best-performing industry in industrials over the past 12 months. And there is a tailwind, as Ned Davis Research reports that defense spending tends to grow twice as fast under Republican presidents as Democrat presidents.

But how much money does that leave in the budget for infrastructure spending that many industrial investors seemed to be hoping for? Meanwhile, raised geopolitical tensions aren’t likely to have a positive impact on business spending plans, which could result in capex spending delays. And with midterm elections not too far off, whether defense spending will continue to grow could depend on which party keeps or gains control of Congress.

Picking through the maze

So what should investors do?  For most investors, our suggestion for the present is to keep a market weighting on the sector, with broad exposure that will likely offer benefits to offset negatives that may come with the same development. For those investors who want to be more aggressive, we believe there are some potential opportunities within the sector that may be worth investigating for some more targeted investments. But for those investors, we continue to recommend an overall market weighting to the entire sector, so if they decide to overweight a specific industry they likely would need to pare back other areas of the group. The industrial sector is challenging, representing a broad swath of our American economy, and for now those challenges result in a roughly balanced view in our mind, and a marketperform rating.

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 06/05/18

Consumer discretionary

Marketperform

07/17/2014

13%

10.28%

Consumer staples

Marketperform

05/07/2015

7%

-12.21%

Energy

Marketperform

11/20/2014

5%

5.35%

Financials

Outperform

05/07/2015

15%

-1.26%

Health care

Outperform

01/26/2017

14%

1.62%

Industrials

Marketperform

01/29/2015

10%

-0.23%

Information technology

Outperform

04/29/2010

25%

14.84%

Materials

Marketperform

01/31/2013

3%

-0.61%

Real estate

Underperform

01/26/2017-

3%

-2.61%

Telecom

Underperform

09/12/2013

2%

-9.78%

Utilities

Underperform

05/23/2013

3%

-5.24%

S&P 500®  Index (Large Cap)

 

 

 

3.68%

Source: Schwab Center for Financial Research and Standard and Poor’s as of 05/31/18.

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.

What You Can Do Next

To discuss how this article might affect your investment decisions:

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Materials Sector Rating: Marketperform

Important Disclosures

Schwab Sector Views do not represent a personalized recommendation of a particular investment strategy to you. You should not buy or sell an investment without first considering whether it is appropriate for you and your portfolio. Additionally, you should review and consider any recent market news.

All expressions of opinion are subject to change without notice in reaction to shifting market or other conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Diversification and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

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 S&P 500® Industrials Index comprises those companies included in the S&P 500 that are classified as members of the GICS®  Industrials sector.

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.

Global Purchasing Managers Index - PMI' is an indicator of the economic health of the manufacturing sector. The PMI index is based monthly survey of the world’s leading economies,on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

The ICE U.S. Dollar Index is a geometrically-averaged calculation of six currencies weighted against the U.S. dollar. The contract was established in 1973 and includes six currencies: the Euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc

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.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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