Industrial Stocks Facing Short-Term Setback

Industrial stocks have experienced a slight downturn this month, following substantial gains in 2023. However, this presents an excellent opportunity for those who have confidence in the U.S. economy to consider investing in these companies.

The decline can be observed in the Industrial Select Sector SPDR exchange-traded fund (XLI), which consists of various manufacturing stocks. It has fallen approximately 3% to $108, after reaching a record high of just over $110 in August. One of the factors contributing to this decline is the recent surge in interest rates, which has dampened the fund's impressive growth of nearly double-digit throughout the year.

Understandably, investors are concerned. Federal Reserve Chairman, Jerome Powell, recently emphasized the central bank's commitment to maintaining elevated rates for an extended period to curb economic demand and inflation. As a result, this could negatively impact companies like Caterpillar (CAT) and other manufacturers who rely on heavy equipment sales, particularly during a slowdown in new construction projects. Additionally, transportation companies like FedEx (FDX) may also suffer, as reduced consumer and business demands lead to a decrease in goods delivered. Consequently, both Caterpillar and FedEx stocks currently sit 2.1% and 3.7% below their respective peaks.

Despite these challenges, the market recognizes the silver lining: the potential resilience of economic demand and the anticipated growth in earnings for industrial companies. Analysts surveyed by FactSet predict that companies within the Industrial Select Sector SPDR ETF will achieve a solid 13% annualized earnings per share growth between 2024 and 2025. This positive outlook suggests that this short-term setback may indeed present a favorable buying opportunity for investors looking to capitalize on the future prospects of the industrial sector.

Gaining Momentum: Industrial Sector Poised for Growth

As the Federal Reserve shows signs of pausing further rate hikes, coupled with an economic rebound from the first quarter of 2023, the industrial sector could potentially experience substantial gains. Industry analysts already anticipate a positive upswing in sales and earnings per share (EPS) for companies like FedEx. After a predicted low in their August quarter at $21.8 billion and $3.68 respectively, sales and EPS are expected to rise to $23 billion and $5.78 by the May quarter. Additionally, manufacturers and construction-focused firms are likely to benefit from increased government spending on infrastructure.

This upward trajectory in earnings has the potential to drive stock prices within the industrials sector higher as well. Currently, the Industrial Select Sector SPDR ETF is trading at around 18.2 times forward EPS estimates, which is below the S&P 500's ratio of 18.7 times. Historically, when investors favor industrials, this fund typically trades at a premium multiple. Therefore, with its current lower price, buyers may become more confident and seize the opportunity to invest.

The recent price trends within this sector further support its potential for growth. Since July, there has been consistent buyer activity around the $105 mark, helping to sustain the ETF's value. Moreover, this price level aligns closely with the 200-day moving average, which has acted as a strong support since the ETF initiated its upward trend in October of last year.

As of Tuesday afternoon, the fund showed a 0.6% increase in value, trading at $108.06.

Conclusion: With a positive outlook for both sales and EPS in the coming quarters, as well as favorable price trends and investor confidence, the industrial sector appears poised for promising growth opportunities.