The U.S. industrial sector is all set for lift-off after a sluggish first half of the year due to the geopolitical tensions in eastern Europe. We have already started seeing the signs of a rebound as the S&P 500 Industrials is up nearly 4% since the beginning of July 2022, outperforming the major S&P 500 index, which is up only 3%.
Companies involved in manufacturing machinery, equipment and supplies used in construction activities are a part of the industrial sector. Few of the top companies in this sector are Lockheed Martin (LMT), Honeywell International Inc. (HON) and 3M Company (MMM). They are also some of the top constituents in the S&P 500 Industrials index.
Exhibit 1: S&P 500 vs S&P 500 Industrials QTD Performance
Source: S&P Dow Jones Indices. Data as of 15 September, 2022
The role of the industrial sector in the U.S. economy
The industrial sector has a significant impact on the overall U.S. economy. The sector, including construction, accounts for almost a fifth of the country’s total GDP. The manufacturing sector alone accounts for $2.3 trillion, accounting for almost 11% of the country’s total GDP. The sector employs around 12 million people, comprising 8% of the direct employment in the United States.
Exhibit 2: Impact of the Manufacturing Sector on the U.S. Economy
Source: U.S. Bureau of Economic Analysis, U.S. Bureau of Labor Statistics, Mckinsey Global Institute Analysis, August 2022
However, in recent decades, the United States has lost its leading position to China as the world’s leading manufacturer. The U.S. share of global manufacturing output and gross sales have fallen.
Exhibit 3: Top 10 countries by market share of Global Manufacturing Output in 2019
Source: United Nations Statistics Division, Statista.com, May 2021
Picking the best industrial stocks
Industrial sector includes some of the oldest and widely recognised public companies. One of the three major U.S. stock market indexes – the Dow Jones Industrial Average – borrows its name from the sector that supports the U.S. economy.
The strongest companies in the industrial sector have the following business characteristics:
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- Diversified operations provide some protection during economic downturns when demand for industrial goods goes down
- Low cost structure which offers less exposure to rising cost pressures during inflationary times
- Investment grade credit ratings which allow them access to affordable debt given their capital intensive nature
- Strong financial performance indicating the companies’ resilience in times of crisis
Exhibit 4: Industrial Stocks Valuation and Price Potential
Source: Stockal Research. Data as of 14 September, 2022
Exhibit 5: Annualised Returns (%) of Industrial Stocks
Source: Stockal Research. Data as of 14 September, 2022
Conclusion
In the near term, the industrial sector faces challenges from a potential slowdown in global economic activity due to rising inflation and supply chain bottlenecks. However, many industrial companies have established businesses with a proven track record of successfully manoeuvring during the economic cycle of boom and bust. They are also poised to gain from increased public spending on national infrastructure as the Biden Administration passed a $1.2 trillion Infrastructure Bill last November. Nevertheless, given the cyclical nature of the industrial sector and the current volatility in the markets, buying and holding onto stocks seems like an appropriate strategy while the power of compounding works its magic!
