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The Industrials Sector

October 21, 2018

 

 

Concern about global trade tensions has hurt industrial stocks. But that risk may now be priced in and valuations might start to look attractive again. The industrials sector is made of large multinational manufacturers, defense companies, equipment makers and aerospace firms. Investors have seen this industry has been buffeted by trade conflicts this year, but the risks aren’t going away. However, it is important to note that portfolio managers have a better handle on the situation and believe trade risks have already been factored in stock valuations. Not only that, but they also have characteristics that could enable them to grow in the coming years.

 

The industrials market has been lagging in the stock market for the past ten years. We saw the sector suffer as oil prices fell in 2015, China allowed the yuan to devalue against other major currencies and industrial activity slowed before turning around in late 2016. It is critical to picture the growing industrial cycle, which could last until 2020. Recently, we have seen industrials outperform the defensive sector even as they remain among the worst cyclical sectors. Industrials are now trading somewhere along the lines of a 15.4 price-to-earnings ratio based on the 2019 estimates. This ratio is below the S&P 500 price-to-earnings of 15.9 as well as below a price-to-earnings of 19.5 and 17.4 for consumer discretionary and technology respectively. The sector’s price-to-earnings has contracted about 20% from 2017’s peak levels. Among cyclical sectors, industrials currently trade at the largest discount to their 2017 peak, excluding energy. They also have the lowest price-to-earnings excluding financials.

 

The under performance and attractive valuation of industrials recently is in part due to investor concerns over current trade disputes. New tariffs have already started to raise material costs and trade disputes have already started to disrupt supply chains globally. Investors should keep in mind that the management team has already provided guidance on how trade policy will impact them and how they might respond to the additional tariffs through options like price increases or supply-chain shifts. Industrial companies seem well prepared and have given their significant contracted price-to-earnings multiples and may see the strongest rebound when macro-trade fears eventually dissipate.

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