A False Recession Signal Is Here: Analyst Torches Theory Around Industrial Stocks

Industrial stocks are getting a lot of attention from investors as a potential recession sign. The theory is pretty simple; if construction companies like Caterpillar Inc CAT and Honeywell Inc HON are struggling, it could indicate weakness in the overall economy as demand for building materials and supplies drop because businesses cut back on spending. 

But, Jessica Rabe, co-founder of Datatrek, argues that weakness in industrial stocks has not been a reliable indicator of recessions in the past. The last time that industrials showed above-average weakness compared to the S&P 500, was in March 2020 when the COVID-19 pandemic shut down many parts of the economy.

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“When industrials have lagged the S&P 500 by 2 standard deviations, it’s been a false signal of recession (Nov 1999/Sept 2021) or concurrent w/ an economic downturn (March 2009/2020),” DataTrek reports. 

Rabe also points out that much of the weakness in the industrial sector comes from the top: the top-10 holdings in the S&P Industrials Sector ETF are down more than 2% on average YTD, while the rest of the holdings are up more than 4%. 

Lockheed Martin LMT and RTX Corp RTX, both top-10 holdings in the industrial sector ETF, are expected to see a significant regression in earnings in 2024 compared to 2023. This could help explain why there is a disconnect between weakness in industrial stocks and an overall recession. Just because there’s a drop-off in demand for defense-related supplies, does not necessarily mean that there will be an overall downturn in the economy.

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