Although Europe clearly has some severe issues, the situation is much better in the U.S. market. While the jobs picture is still cloudy, the industrial side of the equation is looking much more robust.
Recent data suggests that industrial production levels are rising at a solid clip, led by strength in manufacturing and even a move higher in the capacity utilization rate. In fact, this figure is now approaching 80% while inventories are still at a healthy level.
However, while the economy may be improving ever so slightly in the U.S., the sentiment regarding the industrial sector has been decidedly negative as of late. This reversal is partially due to weakness in some of the regional Fed reports and durable goods orders, while fears over lower European and emerging market demand haven’t helped matters either.
Thanks to this shifting perception of the space, the most popular way to invest in the segment in ETF form, the Industrial Select Sector SPDR (NYSEARCA:XLI) has been a weak performer in recent trading. The ultra popular ETF is now up just 3.8% on the year and has slid by about 5.1% in the past month alone.
Meanwhile, from an individual stock perspective, the view isn’t much better. GE (NYSE:GE) performed well to start the year, but has been stuck in a tight and bearish range as of late, casting a shadow over the entire sector. Additionally, United Technology Corp (NYSE:UTX) has seen a similar bout of weakness in the past month and could see more trouble thanks to a downgrade from ratings agency Fitch.
Clearly, the industrial sector, even with decent fundamental data, is quickly become a segment to avoid in the near term, especially if these current trends continue. It appears as though investors are, at least for now, focusing on the global environment rather than looking at some of the otherwise solid prospects in the space.
However, while XLI and a few other large cap focused, passive ETFs have floundered in recent months, the trend hasn’t been universal by any means. Instead, a number of ETFs have managed to put up solid gains in this uncertain market environment bucking the bearish tone that is clearly plaguing most of the securities in the industrial sector.
Below, we highlight three of these industrial ETFs which have outperformed XLI in both the current quarter and from a year-to-date look as well. While there is no guaranteeing that any of these products will continue to outgain their State Street counterpart, it is probably worth noting which segments of the broad industrial sector have been the star performers during this difficult time:
Despite some concerns over business travel and oil prices, the airline industry has been a solid segment of the Industrial sector. FAA is now up close to 9.7% over the course of 2012 while it has lost just 1.4% so far in the quarter.
Clearly, the product has been helped by slumping oil prices and some bargain buying in the space as of late helping to push this product away from its 52 week lows. Oil prices represent a significant input cost for airlines so the $15/bbl. slide over the course of May certainly helped FAA hold up nicely in the otherwise rough market for industrials.
In terms of holdings, the ETF has about 25 securities in its basket, with airlines coming from around the world. Major U.S. airlines dominate the top spots although close to 25% of the fund is from international airlines as well.
For the style box, blend securities comprise roughly half of the assets while value takes up much of the rest. However, this value tilt is likely balanced out by the strong mid cap presence in the fund as just 7% of the product is in large caps or bigger.
While some foreign markets may be slowing down, it appears as though investors haven’t yet soured on the international industrials market. This developed market fund is up more than 11% so far this year while it has lost just 2.1% so far this quarter.
This might be somewhat surprising to investors as the product has significant exposure to European securities in its portfolio. The product also puts nearly 23% of its assets in securities that are euro denominated, a situation which probably hasn’t helped the return as of late.
Instead, the product appears to be saved by its solid exposure to Japan (29%), and strong European countries such as Germany, Switzerland, and Sweden. Beyond this, the product puts just about 5% in PIIGS nations, suggesting that the exposure to the weakest economies of all is pretty light.
Thanks to this profile as well as a heavy focus on large cap securities, AXID has managed to avoid much of the turmoil that the rest of the industrial sector has faced. Additionally, since the fund holds over 220 securities in its basket and pays a solid yield of over 3%, it has been a less volatile play on the segment as well.
Much like the developed markets, emerging market industrials have managed to avoid much of the turmoil in the past few weeks, largely thanks to solid growth prospects. While this has admittedly come down in recent sessions, emerging markets still are among the highest growth areas that investors have left. In fact, so far in 2012, IGEM has added about 15.3% while it has lost about 3.2% since the beginning of the quarter.
However, investors should note that the product is very thinly traded and is much more expensive than other industrial ETFs on the market today. Additionally, it isn’t a pure industrial play as it has significant exposure to consumer and basic material stocks as well. Lastly, the ETF is also trading at a large premium to NAV, a factor that can work in an investor’s favor initially, at least until this eventually collapses.
Still, the product has been the top performer in the industrial space so far this year, while during down markets its losses have been quite tolerable. This is likely due to the heavy focus on both value securities and those in the large cap space.
Beyond this, investors should also note that the fund has a significant holding in Indian and Chinese securities (close to 50% of the portfolio in these two nations) while South Africa, Malaysia, and Mexico round out the top five. This diversified country exposure helps to take the sting out of the relatively small portfolio size — 30 firms — and less concentrated portfolio.