Getting Defensive on Industrials

With the large cap Industrial sector so much in the news because of the market’s new fears over trade tariffs/wars, we want to take a look at the group today through the lens of the names that dominate it. Industrials themselves are just 10% of the S&P 500, slotting in between Consumer Cyclicals (12% weight) and Consumer Non-Cylicals (8%). Overall YTD performance here was spot in-line with the S&P through Wednesday, February 28th, with large cap industrials up 1.5% on the year and the 500 up 1.3%. 

As of Friday’s close, however, the Industrials are now underperforming the S&P 500 by over 100 basis points YTD: down 0.77% versus +0.66%. All the damage came in the afternoon on Thursday and a gap down open on Friday.

To see what may (if anything) be worth buying on this pullback, let’s look at the companies that dominate the sector and their weightings:

• Boeing: 8.1% of the large cap Industrial sector
• 3M: 5.7% weight
• Honeywell: 4.8% weight
• Union Pacific: 4.4% weight
• United Technologies: 4.0% weight
• Caterpillar: 3.8% weight
• GE: 3.7% weight
• Lockheed Martin: 3.6% weight
• UPS: 3.0% weight
• Raytheon: 2.7% weight
• Total weight of Top 10: 44%

While the Industrials are not as top heavy as Technology (+50% represented by the top 10 stocks), these names clearly matter most. A look at their price performance yields three insights:

• As is the case with the Dow Jones Industrial Average, Boeing plays an outsized role in how this group has and will continue to perform. BA is up 17% YTD, contributing to the group’s performance in 2018 by 130 basis points. Ex-Boeing, this group would look far worse on a performance basis than its actual -0.77% return YTD.

• GE is the problem child here, down 19.1% YTD. Its performance has clipped the group for 70 basis points; not enough to eliminate Boeing’s tailwind on the Industrials, but still a problem for the sector. For those readers curious about the name, we have a standing personal policy of “Never buy a new low; wait for it to settle out.” Enough said there…

• The real standouts – and the names to watch – are the large defense stocks (Lockheed Martin, Raytheon, and to a lesser extent United Technologies and Boeing). All are still up on the year, and some dramatically so: RTN (+14.3%), LMT (+6.4%), and UTX (+1.9%).

To the degree that markets will worry about trade and tariffs for some time, it makes sense that investors will rotate into the Defense stocks and out of traditional “Industrial” names. They have already been doing well on the premise that both geopolitics and domestic policy favor them. Now, they have a new catalyst: worries over protectionism.