Is Manufacturing The Key To The Industrial Sector?

If market watchers had to point to one stock that encapsulated the rally in the industrial sector, it would likely be Caterpillar. And while CAT’s late-summer performance is impressive, gaining 15 percent over the course of a 30-day span that saw stocks like Amazon.com, Inc. AMZN and Apple Inc. AAPL trade relatively flat.

However, Caterpillar is only one part of a far more complex story, one that becomes clearer when you take a broad sector ETF like the Direxion Daily Industrials Bull 3X Shares DUSL and put it up against more narrowly focused ETFs like the Direxion Daily Transportation Bull 3X Shares TPOR and Direxion Daily Aerospace & Defense Bull 3X Shares DFEN.

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Of the three, DUSL has actually shown the weakest growth and highest negative reactivity over the past three months. While the difference is modest, there are reasons the industrial success narrative is actually facing some headwinds, with more obstacles likely cropping up to spoil the Cinderella story.

First, the most apparent anchors weighing on the broad industrial sector are indeed the legacy materials and manufacturing giants like General Electric Company GE, 3m, Inc. MMM, and, yes, Caterpillar.

GE’s problems are already well known, suffice it to say they are trading at prices they haven’t seen since the 90s and the best expectations for upcoming earnings report is that the company might finally have hit bottom. 3M, on the other hand, has traded down largely on those lingering trade fears backed up by lower corporate guidance through 2018. While not as bleak a picture as GE, 3M is also facing increased downward pressure due to its China exposure.

Honeywell International Inc. HON might actually have the best-looking balance sheet of the lot, posting across-the-board earnings beats in the past six reporting periods. Its planned automotive split, Garrett Technologies, also bodes well for lowering costs, which could be contributing to its new all-time highs.

Then there’s Caterpillar, which has actually traded relatively flat through the summer and is still at an 8 percent discount from its 2018 high back in January. This is despite analyst enthusiasm, strong revenue reports, and corporate guidance above the Street’s estimates. Said guidance, however, also highlighted the headwind of materials costs in steel and aluminum, which tariffs only went into effect at the tail end of Q2. At the same time, clients like farms and construction firms are also now contending with rising price tags, all of which could dampen the excitement developing around CAT.

This isn’t to say Industrials aren’t performing well now, or that the sector might not carry on as briskly. However, industry specific investments in Transportation and Defense have fewer immediate obstacles threatening to spoil the fun.

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