Why Industrial Stocks Are Racing Past S&P 500 Despite Trade War

The protracted trade war between the U.S. and China, plus decelerating global GDP growth, were supposed to hurt industrial stocks. Nonetheless, for the year-to-date through Wednesday, the S&P 500 Industrials sector has surged by 18.93%, outpacing the 16.23% advance in the S&P 500 Index (SPX), per S&P Dow Jones Indices.

New orders for non-defense capital goods rose by 0.4% from April to May and, overall, businesses are still making expensive investments, wrote Paul Ashworth, an economist at Capital Economics, in a note to clients cited by The Wall Street Journal. Leading industrials include Emerson Electric Co. (EMR), Honeywell International Inc. (HON), Union Pacific Corp. (UNP), CSX Corp. (CSX), Stanley Black & Decker Inc. (SWK), General Electric Co. (GE), and Boeing Co. (BA).

Significance For Investors

While new orders for non-defense capital goods were up in May, overall durable goods orders were down by 1.3%, the report adds. This was due to lower orders for commercial aircraft, particularly Boeing's troubled 737 Max jetliner.

This trend has translated into big gains for Honeywell, which has been a particular standout among industrials, sprinting upward by 32.7% year-to-date through June 26, per data from Yahoo Finance. Organic sales from existing operations were up by 8% year-over-year (YOY) in the first quarter, and total sales beat consensus estimates by 2.9%, per data from FactSet Research Systems cited in another Journal report.

Demand in China for Honeywell products related to the workplace was a key factor in the strong results. Additionally, organic sales in its aerospace division jumped by 10% YOY. In May, the company raised its guidance on profit margins in aerospace, expecting them to expand from 25% to 27% in the long term, per Barron's.

The Global Outlook

Despite indications that global growth is slowing as industrial production contracts in China and Germany, Julian Mitchell, an analyst with Barclays, has an upbeat view. “We don’t believe in the globally synchronized hard landing narrative,” he told Barron’s.

Mitchell's research indicates that the manufacturing slowdown is largely in autos and electronics, and is not spreading. He observes that growth has been decelerating for roughly 18 months, and he believes that it is bottoming out. “We understand this is a somewhat contrarian call,” he wrote in a note to clients, as quoted by Barron's.

Indeed, history indicates that manufacturing downturns last an average of 18 months, and industrial production growth peaked in Dec. 2017, according to Jeremie Capron, head of research at ROBO Global, an index, advisory and research firm, per another Barron's report. Meanwhile, China has been stimulating its manufacturing sector with tax cuts and credit expansion. Capron notes that shares of Japanese exporters of industrial technologies have risen despite declining orders and lowered guidance, leading him to conclude that "we are at a bottom."

Looking Ahead

During the G-20 summit that opens in Osaka, Japan on Friday, a meeting is scheduled for Saturday between President Trump and President Xi Jinping of China. Trade tensions between their countries are expected to be the major topic of discussion, and industrial stocks are bound to be particularly sensitive to any announcements or rumors regarding the future direction of tariffs and trade restrictions.