In 2018, U.S. industrial stocks had their second-worst year relative to the broad U.S. equity market in two decades, but so far in 2019, the sector has come back strongly. In this article, our industrials analysts look at some of the reasons for the sector’s recent swings, and how they approach investing in a space where valuations and sentiment can shift rapidly.
Industrials within the S&P 500® Index underperformed the Index overall by 8% in 2018—one of the sector’s worst showings in twenty years. But in the early weeks of 2019, industrials were up more than 6% (as of 2/28/19), outpacing the broader market by a notable margin. What drove this reversal of fortune?
In our view, the answer is less about any fundamental changes in conditions, and more about sentiment and expectations—specifically, expectations about capital expenditures across the economy.
Over the course of 2018, investors faced one uncertain scenario after another. In the U.S., the direction of the Fed’s interest-rate moves was an ongoing concern, in addition to the anxiety leading up to November’s 2018 midterm elections and a host of other politically charged issues. Investors also worried about inflation—both from rising commodities and higher wage costs —as well as from strong concerns about wage growth affecting companies with a large service component. China continues to loom large as worries mount over its economic growth both from the direct impact from the trade war as well as from the cooling off of the property sector and consumer spending fears—particularly around autos. In addition to trade friction, other global concerns include tariff disputes, Brexit, Italy’s fragile political situation and more.
All of these factors led investors to fear that companies would delay and/or reduce capital spending plans, which in turn drove down sentiment for U.S. industrial stocks throughout the year.
However, a number of the market’s fears cleared up in early 2019. The Fed has signaled a pause and/or slowdown in rate hikes, for example, and investors now appear to be more optimistic about trade conditions between the U.S. and China. The resulting relief and optimism about industrial activity helped to buoy stock prices through February. Again—we believe that all of this up-and-down volatility was driven more by sentiment than by meaningful fundamental changes.
Finding Stability on Shaky Ground
These sorts of swings are not new for the U.S. industrial sector. Due to the sector's cyclical nature, industrial stocks are typically sensitive to changes in economic sentiment. We try to be long-term owners of industrial companies we believe have great business fundamentals, and that can require patience during periods when the market sours on a specific subsector or on industrials broadly. By remaining focused on business drivers versus market sentiment—and seeking out companies whose fundamentals are holding up well relative to peers—we can be more confident owning these companies for the long term. This approach can also reveal moments when we can build a new position, or add to an existing one, at what we view as especially attractive valuation levels.
A recent example is Aptiv, a supplier in the automotive sector that we have owned across several strategies in recent years. The company’s product portfolio is quite differentiated, with a focus on technology for safety, connectivity and infotainment. Its offerings are increasingly valued by automakers as cars become more sophisticated technology platforms. Over the past eight quarters (see chart below), global auto sales have lagged, and U.S. auto sales have also faltered. Meanwhile, Aptiv has continued to generate solid revenue growth as it adds new content and gains market share. Against this backdrop, we have been able to buy more Aptiv opportunistically, increasing our ownership in line with our strong conviction in the company. Despite the fact that the stock has lagged in sympathy with the U.S. auto sector as well as overall weaker industrial sentiment, we feel confident in the company’s prospects.
Bucking the Trend
While global auto sales have lagged, Aptiv (APTV) has continued to grow and thrive due to an innovative, differentiated product platform. Strong fundamental prospects give us confidence to own companies like Aptiv, even when market sentiment is against us.
Source: Bloomberg and Aptiv PLC company report.
We invest in a number of U.S. industrial firms that we consider to be excellent operators and stewards of capital. To confidently hold these companies for the long term, we cannot be unduly influenced by sentiment or even the inevitable ebbs and flows of cyclical factors. It may sound overly simplistic, but we believe that positive business results translate into positive equity returns over time.
The views expressed are those of Brown Advisory as of the date referenced and are subject to change at any time based on market or other conditions. These views are not intended to be and should not be relied upon as investment advice and are not intended to be a forecast of future events or a guarantee of future results. Past performance is not a guarantee of future performance and you may not get back the amount invested.
The information provided in this material is not intended to be and should not be considered to be a recommendation or suggestion to engage in or refrain from a particular course of action or to make or hold a particular investment or pursue a particular investment strategy, including whether or not to buy, sell, or hold any of the securities mentioned. It should not be assumed that investments in such securities have been or will be profitable. To the extent specific securities are mentioned, they have been selected by the author on an objective basis to illustrate views expressed in the commentary and do not represent all of the securities purchased, sold or recommended for advisory clients. The information contained herein has been prepared from sources believed reliable but is not guaranteed by us as to its timeliness or accuracy, and is not a complete summary or statement of all available data. This piece is intended solely for our clients and prospective clients, is for informational purposes only, and is not individually tailored for or directed to any particular client or prospective client.
The S&P 500® Index represents the large-cap segment of the U.S. equity markets and consists of approximately 500 leading companies in leading industries of the U.S. economy. Criteria evaluated include market capitalization, financial viability, liquidity, public float, sector representation and corporate structure. An index constituent must also be considered a U.S. company.
Standard & Poor’s, S&P, and S&P 500 are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”), a subsidiary of S&P Global Inc.
Sectors are based on the Global Industry Classification Standard (GICS®) classification system. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard & Poor’s. “Global Industry Classification Standard (GICS), “GICS” and “GICS Direct” are service marks of Standard & Poor’s and MSCI . “GICS” is a trademark of MSCI and Standard & Poor’s.
BLOOMBERG, BLOOMBERG PROFESSIONAL, BLOOMBERG MARKETS, BLOOMBERG NEWS,BLOOMBERG ANYWHERE, BLOOMBERG TRADEBOOK, BLOOMBERG BONDTRADER, BLOOMBERG TELEVISION, BLOOMBERG RADIO, BLOOMBERG PRESS, BLOOMBERG.COM and BLOOMBERG LAW are trademarks and service marks of Bloomberg Finance L.P., a Delaware limited partnership, or its subsidiaries.
All financial statistics are calculated using information from FactSet as of the report date unless otherwise noted. FactSet® is a registered trademark of FactSet Research Systems, Inc.