Much of what we said above about financials holds true for another sector that has rallied strongly in the month since the election: industrials.
As of this writing, industrials as a whole have rallied 12% in the past month, accounting for just under half of the index’ year-to-date gains. As with financials, the overall gain conceals large divergences in the underlying industries.
Construction and engineering firms, construction materials, machinery, and road and rail rallied strongly -- with buyers casting about to find the most down-and-out merchandise that would benefit from Mr. Trump’s vaunted infrastructure stimulus.
We believe that the turn in industrials will be real as well. However, the implementation of policies is more complex, more contentious, and will take longer. As it becomes apparent that the infrastructure push may not begin in earnest until 2018, many of the companies that have rallied strongly since November will experience pullbacks.
Among industrials, we favor steels, particularly vertically integrated companies with captive iron ore, coal, and coke supplies. Chinese producers set the global price, and they will be raising prices to compensate for the higher spot prices they will be paying for their inputs. Vertically integrated steels will benefit from steel price increases, while being able to control their input costs.
Further, among industrials, we favor mid-sized companies due to their relative lack of exposure to dollar-related earnings issues. (Mid-cap industrials have on average rallied 13.7% in the past month, compared to 10.2% for the big caps, and 9.4% for the mega caps.)
Investment implications: Mr. Trump’s victory prompted a strong rally in U.S. industrial stocks. We believe this rally is justified by the magnitude of the policy shift that the Trump administration promises to implement, and by the prospect of a growth inflection in the U.S. economy that lengthens the current expansion and finally gives cyclicals some much-delayed mojo. However, we caution that unlike some of Mr. Trump’s proposed fiscal and regulatory policy turns, the policies that boost growth and bolster U.S. industrials will take longer to implement, and their political path is less certain. There will be pauses, setbacks, and conflicts, during which market participants lose their nerve -- and the ensuing corrections will be buying opportunities, as the revitalized expansion may not hit its stride until 2018. Among industrials, we favor small and mid-sized companies with less exposure to exchange rate effects; we like truckers, and we like vertically integrated steels with captive iron ore, coal, and coke.