Rusting Out?

by: Douglas Tengdin, CFA

Is the industrial sector over?

Industrial stocks have gone sideways relative to the market for two decades. They lagged during the internet bubble, boomed with the BRICs mid-decade, suffered with everyone else in the Financial Crisis, and have been gradually recovering since. But even though their profit margins are expanding, the sector has just moved up or down with the general market. Is there any dynamism left?

Industrial companies feed our non-technology capital spending. When countries want to build bridges, they use big earth-movers; when airlines expand, they buy new aircraft and jet engines. And railroads are the most efficient way to ship stuff across the country. But over the past five years capital spending has been dormant. Companies have been reluctant to expand their own capacity and build new factories.

At the same time, emerging countries have slowed their torrid growth. While they are still growing, they are shifting their economies from being export-driven to a consumer-based model. In addition, the lower gas prices that cost us less at the pump mean that oil companies don't need as many drilling rigs or as much other equipment. Finally, a strong dollar means company earnings overseas don't translate into as many dollars back home. The strength of the dollar is pulling profits lower.

All this means that industrial firms will face challenges going forward. That doesn't mean investors should just sell out - a diversified portfolio has exposure to all the major sectors. Just don't be surprised when the road gets bumpy.