As investors entered the holiday season sanguine over the Trump trade and the strong economy’s potential for producing good stock returns in this new year, industrials weren’t particularly high on many Santa analysts’ “nice” lists.
This lack of enthusiasm is a bit curious, considering the sector’s performance in this bull market and solid fundamentals indicating good prospects for this New Year.
As of mid-December, industrials had grown nearly as much as the Magnificent Seven-dominated S&P 500, returning about 25% over the preceding 12 months, as indicated by The Industrial Select Sector SPDR® Fund (NYSE:XLI). Along with almost everything else, industrials subsequently pulled back, but then rebounded somewhat December 20.
Though industrials may not be the Rodney Dangerfield of sectors — they get some respect — regard for them among many analysts is a bit tepid. Despite this sentiment, there are various indications that the sector is poised for another good year—a likely component of the broadening market performance that many of these same analysts are projecting.
Most of these analysts seem reluctant to bestow on industrials the same encomiums they reserve for financials, energy, materials, communications services, utilities and, of course, tech stocks with an AI story.
Most of them, that is. But there are some adroit outliers.
Quiet Leadership
In an appearance on CNBC in September, Strategas analyst Chris Verrone seemed to question the lack of true love for industrials, calling it a “quiet leadership sector” over the preceding two years. He pointed out that industrials are a strong economic bellwether — a sector highly reflective of the overall economy. Growth in the world’s most consumer-powered economy won’t happen unless consumers are buying products made with equipment industrial companies sell to manufacturers, and vice-versa.
“I think industrials have been telling us for 18 months that we’ve been in a soft landing,” Verrone said. “Will it persist? If [economic conditions] are going to deviate from the status quo, wouldn’t that involve the most consistent group at that time weakening? And we just haven’t seen it.”
We still haven’t seen industrials weakening relative to the broader market, and probably won’t see it this year. And economists sticking to their earlier projections for a crash economic landing are now few and far between.
Since Verrone made these statements, earlier, incessant market chatter about “the landing” has diminished amid abundant signs that the metaphorical economic aircraft has touched down and is taxiing on a runway smoothed by the confidence of the Fed.
Perhaps a little too much confidence for the market. In announcing a 25-basis-point cut December 18, Powell nevertheless signaled the potential for less rate-cutting in 2025 than previously expected, sending downward a market with valuations reflecting more cuts.
Never mind that the reason for less cutting, the economy’s remarkable robustness, propels market growth; much of the market is too short-term to focus on that.
But because of this characteristic short-termism, the market naturally twitches up and down with each varying indication. The Dec. 20 bounce-back came as Fed Austan Goolsbee, Chicago Fed president, indicated in a media interview that considerable rate-cutting is still likely in 2025, as inflation is nicely on track toward the Fed’s goal of 2%.
In the ensuing holiday season, one without the usual Santa Claus rally, XLI dipped with the market but then, in the early days of 2025, bounced back a bit to post a 12-month gain of about 20%, as of Jan. 6.
Of course, this was below the S&P’s 12-month gain as of that date—28%, as measured by SPY—but XLI nevertheless still was and is nicely positioned for this new year, with sanguine analysts’ ratings for major holdings including GE Aerospace (NYSE:GE), Honeywell (NASDAQ:HON), Caterpillar (NYSE:CAT) and Uber (NYSE:UBER).
Higher For Longer
If higher-rates-for-longer continues indefinitely, says market economist Ed Yardeni, that wouldn’t be a problem for an economy so strong that it seems impervious to the normal constraints imposed by restrictive monetary policy. Thus, Yardeni argues, sustained high rates won’t constrain growth much, if at all.
Yardeni sees the rest of this decade as an economic reincarnation of the Roaring ’20s, when industrials soared — the Roaring 2020s (but without an ensuing 1929-style collapse at the decade’s end).
Regardless of this exuberance — or precisely because of it — investors considering purchases may want to evaluate the potential impacts of these trends on the sector:
- Confidence by industrial companies reflected by an increase in domestic spending of more than 50% over the last four years on manufacturing machinery and equipment, according to a study by Apollo using Census data. Industrial concerns must have spent all this money because of projections of higher demand.
- Increasing domestic manufacturing capacity in recent years. Contributing to capacity during this period were the stimulative effects of federal fiscal policy — the Inflation Reduction Act, the Infrastructure Act and the Chips and Science Act, which more than compensated for the negative effects of high interest rates, the Apollo study shows.
- Increasing reshoring — the practice of U.S.-based multinational companies re-siting overseas manufacturing plants on U.S. soil. Most of these companies’ plans for reshoring stem from supply-chain woes they suffered during and after the pandemic from manufacturing shutdowns in China and shipping bottlenecks, as well problems resulting now from the war in Ukraine. By bringing plants home, companies are seeking to avert such problems and generally reduce corporate geopolitical risk. The new plants on American soil of course require new industrial equipment.
The abundant availability of public energy, and a nascent trend of companies arranging proprietary power, including nuclear, to assure that they can fill orders expected to rise.
Stock Picks
The companies best able to capitalize on these trends of course include those with stronger positions from lower risk profiles.
Our screening process to identify companies with low downside risk, according to various fundamentals, produced 15 names:
Smith AO Corporation (NYSE:AOS), Apogee (NASDAQ:APOG), Allegion (NYSE:ALLE), Masco Corp (NYSE:MAS)., Owens Corning (NYSE:OC), Deluxe Corp (NYSE:DLX)., HNI (NYSE:HNI), {{0|Brady}
} Corporation (NYSE:BRC), Steelcase Inc (NYSE:SCS), Donaldson Company Inc (NYSE:DCI), Caterpillar Inc (NYSE:CAT), Dover Corp (NYSE:DOV)., Snap-On Inc (NYSE:SNA), Korn Ferry (NYSE:KFY) and Science Applications International Corp (NASDAQ:SAIC).
Of this group, Deluxe, HNI and {{0|{{0|Brady}
}} } have the highest projected five-year earnings projections. Deluxe has the highest dividend yield, at about 5.15%.
All 15 stocks have attractive valuations, most with trailing 12-month P/Es below 20.
Some of the 15 have fairly high profiles — including A.O. Smith, Steelcase (NYSE:SCS), Caterpillar, Snap-On and Korn Ferry.
But these three are a bit below the radar:
· Brady. (BRC). {{0|{{0|Brady}
}} } makes workplace safety products including those found in factories: safety signs, traffic signs and control products, floor-marking tape, pipe markers, labeling systems, spill-control products, lockout/tagout devices, personal protection equipment, first-aid products, and software and services for safety compliance auditing. Reshoring is a positive for them. {{0|{{0|Brady}
}} } has nice earnings growth, a street target price 14% above the current one and a forward P/E of only 15. Dividend growth 118% over the last decade.
· Allegion (ALLE). Allegion makes door control systems and exit devices, locks, locksets, portable locks, key systems and services; electronic security products and access control systems; and time, attendance and workforce productivity systems. The company has good earnings growth, a street target price 10% above the current price and a forward P/E of only 17.5, despite share-price growth of 34% in the last six months. Dividend growth over the last 10 years: 500%.
· Donaldson (DCI). Donaldson makes filters for all kinds of fluids (a basic razor-blade business model.) The company has good earnings growth, a street target price 7% above the current one, and a forward P/E of 18. Dividend payments have grown 100% over the last decade.
Seldom do stocks with such virtues remain under the radar for long.
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Dave Sheaff Gilreath, CFP,® is a founder and chief investment officer of Sheaff Brock Investment Advisors, a firm serving individual investors, and Innovative Portfolios,® an institutional money management firm. Based in
Indianapolis, the firms are managing assets of about $1.4 billion, as of September 30.
Investments mentioned in this article may be held by those firms, affiliates, Innovative Portfolios’ ETFs, or related persons.