Jacob Sonenshine

Among sectors that could break out to record highs, industrials are one of the strongest candidates.

The Industrial Select Sector SPDR exchange-traded fund tracks large-capitalization U.S. companies in manufacturing and transportation, and includes airlines and ride-hailing firm Uber Technologies. Shares of the ETF are at just over $142 on the back of a more than 1% gain Tuesday. The entire market is rallying as President Donald Trump walked back comments about new tariffs on European goods, just another signal that the worst-case scenario for tariffs is unlikely to play out.

Now, the industrial ETF would only need an additional gain of just over 1% to reclaim its record close of $144, hit earlier this month. Other sectors are further away from breaking out, with the S&P 500 needing to gain about 4% to reach a new high. Industrials are closer, and the ETF has remained on an uptrend since a major low in 2022. As long as the market continues to believe in the economy, industrials can reach new highs soon.

"Industrials build a recovery to new highs" was the tittle of a bullish note by Adam Turnquist, LPL Financial's chief technical strategist.

Industrials' strength, which has carried them to a more than twofold gain over the past five years, beating the S&P 500's 90% gain, has come on the back of sturdy fundamentals. The companies have increased sales a bit faster than the rate of broader economic growth because of several trends.

Mainly, customers are replacing old equipment with new and pricier automated products that are more efficient. Another trend is that companies are building out more U.S. manufacturing capacity to avoid geopolitical complications such as tariffs, sparking tens of billions of dollars of new sales opportunities. Companies in the industrial ETF produced more than $1.5 trillion of total revenue last year according to FactSet data, so the domestic investments will provide a meaningful boost.

Spending on data-center build-outs, as technology companies invest in their artificial-intelligence capabilities, has continued to grow by a double-digit percentage year over year in recent quarters.

The resulting revenue growth for industrials has sparked faster earnings growth for industrials versus the S&P 500 in the last five years.

The trend looks bankable for the long term, even if short-term interruptions are in the cards, as tariffs lift the cost of imports. Some companies, such as HVAC maker Carrier Global, aren't increasing prices enough to fully offset the cost, pinching profit margins. If companies across sectors ultimately lift prices more, consumer and business demand could suffer, denting sales and earnings for many industrials. But if the demand picture never darkens significantly -- meaning the U.S. avoids a recession -- the market is likely to look past any near-term setback to earnings.

The larger, high-growth trends are solidly in place. With all of the spending on manufacturing capacity to come, analysts currently forecast almost 6% annual aggregate sales growth for the industrial ETF from this year through 2027, according to FactSet. Analysts expect profit margins to rise, as product costs increases would presumably moderate after initial tariffs this year. Costs such as depreciation and interest remain essentially fixed. Analysts project that earnings will grow 12% annually from this year through 2027.

Higher earnings could easily send the stocks higher. Even if they're already expensive -- the fund trades at 23.5 times expected earnings for the coming 12 months, near the highest level in the past three years -- those earnings are likely to be much larger each year. So even if the multiple drops some, the stocks can keep rising over the coming year and beyond.

Industrial stocks that could break out to new highs, and have already been outperforming the S&P 500, are HVAC firm Trane Technologies and large-machinery maker Deere. The two companies have shown strong earnings growth over the past five years.

Considering Uber, its shares only need to gain just over 3% to set a new high. That would serve as helpful leg work in moving the industrial ETF to a record, given that Uber's $187 billion market cap is just over 4% of the sector's total market value.

Stick with industrials.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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May 27, 2025 13:44 ET (17:44 GMT)

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